Around the Circuits

by George M. Basharis, J.D.

Recent Bankruptcy Decisions

Supreme Court

U.S. Supreme Court to Resolve Circuit Split on "Credit Bidding"

The Supreme Court on December 12, 2011, granted certiorari in RadLAX Gateway Hotel, LLC v. Amalgamated Bank, No. 11-166, to decide whether a bankruptcy court may confirm a plan of reorganization that proposes to sell substantially all of the debtor's assets without permitting secured creditors to bid with credit.

A Chapter 11 plan may be crammed down on a rejecting class of secured creditors under one of three approaches. First (and probably most commonly), the plan can provide that the holder of the secured claim will continue to have a lien on its collateral, and will receive deferred cash payments with a present value as of the effective date of the plan equal to the value of the collateral. Second, the proponent can satisfy the cramdown provision as to a dissenting class of secured creditors by selling the collateral provided that the secured creditor's lien attaches to the proceeds, and the claimant either receives those proceeds or some other treatment that provides payment of the value of the collateral as of the effective date of the plan. In a significant departure from existing case law, in decisions that have been criticized by the Seventh Circuit, the Third Circuit in In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010) and the Fifth Circuit in Bank of New York Trust Co., NA v. Official Unsecured Creditors' Comm. (In re Pacific Lumber Co.), 584 F.3d 229 (5th Cir. 2009) each held that a secured creditor does not necessarily have the right to "credit bid" at such a sale. Finally, the plan can provide that the dissenting secured creditor receive the "indubitable equivalent" of its claim.

In River Rd. Hotel Partners, LLC v. Amalgamated Bank, 2011 U.S. Appl. LEXIS 13131 (7th Cir. June 28, 2011), a companion case to RadLAX Gateway Hotel, the debtors' plan proposed auctioning the debtors' assets to the highest bidder, free and clear of all liens, with the initial bid in each auction being supplied by a stalking horse bidder. The plan did not give credit-bidding rights to secured creditors. The creditors objected to confirmation of the plan, arguing that the proposal to sell the collateral free and clear was not fair and equitable as required by Bankruptcy Code Sec. 1129(b)(2)(A). The debtors maintained that the proposed plan satisfied the cramdown requirements of the Code because the creditors would receive the proceeds from the sale of their collateral at auction, and, consequently, the plan gave the creditors the indubitable equivalent of their claims.

The Seventh Circuit declined to follow the Third and Fifth Circuits' prior decisions. According to the court, Sec. 1129(b)(2)(A) lists three distinct ways to dispose of encumbered assets over a secured creditor's objection. Therefore, a sale proposing to give a secured creditor the indubitable equivalent of its claim must be distinguished from the other types of sales covered by Sec. 1129(b)(2)(A). A cramdown sale of collateral is fair and equitable if the collateral is sold subject to the creditor's lien, the creditor is allowed to bid its credit at the sale, or the creditor receives the indubitable equivalent of its claim.

Bankruptcy Court Judgment Exceeds Constitutional Authority

A bankruptcy court did not have the constitutional authority to enter a final judgment on a common law compulsory counterclaim, the U.S. Supreme Court held. Bankruptcy courts have the statutory authority under 28 U.S.C. Sec. 157(b)(2)(C) to hear common law counterclaims to a creditor's proof of claim; however, unless the counterclaim can be resolved as part of the claims allowance process, the U.S. Constitution requires that the counterclaim be brought before an Article III court for final determination.

Prior to filing for bankruptcy, the debtor filed a tort claim against her stepson-creditor in a state probate court, alleging that her stepson had fraudulently prevented his father from including her in a living trust prior to his death. Before the matter could be decided by the state court, the debtor was forced to file for bankruptcy. The stepson filed a defamation claim in the bankruptcy court, and the debtor reasserted her state-law claim as a counterclaim. The bankruptcy court entered judgment in favor of the debtor and awarded her compensatory and punitive damages. The debtor's stepson appealed the bankruptcy court's ruling, arguing that the debtor's counterclaim was not a "core proceeding" and, therefore, the court did not have the power to render a final judgment on the claim.

On appeal, the district court observed that while the debtor's counterclaim fell within the literal statutory designation of a core proceeding, the bankruptcy court did not have the power to render a final judgment because the counterclaim was only somewhat related to the claim against which it was asserted. After an independent review, the district court ruled that the stepson was liable on the debtor's counterclaim. Meanwhile, the state court in which the claim was originally filed ruled against the debtor.

On further appeal, the Ninth Circuit reversed the district court, holding that the earlier judgment of the state court should have been given preclusive effect in the debtor's bankruptcy case. On the jurisdictional issue, the circuit court concluded that a counterclaim is a core proceeding only if its resolution is necessary to resolve the allowance or disallowance of the claim itself and that the debtor's counterclaim did not meet that test.

The U.S. Supreme Court affirmed on constitutional grounds. The Court acknowledged that when a creditor files a proof of claim against a bankruptcy estate, any counterclaim asserted by the debtor against the creditor is within the bankruptcy court's jurisdiction to resolve according to 28 U.S.C. Sec. 157(b)(2)(C). However, it struck down as unconstitutional the power given to non-Article III bankruptcy court judges to resolve common law compulsory counterclaims.

Article III of the U.S. Constitution provides that the judicial power of the United States is vested in U.S. district judges. According to the Court, Congress exceeded that limitation when it enacted 28 U.S.C. Sec. 157(b)(2)(C) to the extent that it gives bankruptcy courts the authority to enter final judgments on state-law counterclaims that cannot be resolved in the process of ruling on a creditor's proof of claim. The Court's ruling appears to lessen the risk to creditors who, by filing a proof of claim, could be submitting to the jurisdiction of the bankruptcy court for all counterclaims of the debtor.

Stern v. Marshall, 131 S. Ct. 2594 (2011)

1st Circuit

Bankruptcy Discharge Bars ADA Reinstatement Claim

A former airline employee's claim for reinstatement in lieu of damages under the American with Disabilities Act ("ADA") constituted a "claim" that was dischargeable in the airline's bankruptcy.

The debtor filed a proof of her claim, the debtor objected, and the bankruptcy court sustained the airline's objection, the debtor having failed to request a hearing to consider the matter. The employee conceded that, to the extent her initial claims would have obligated the debtor airline to pay money damages, they were barred by the bankruptcy court's injunction in its confirmation order.

The debtor argued that because she could have sought relief in the form of reinstatement had she prevailed in her ADA claim, the equitable remedy of reinstatement was not included in the definition of "claim" under the Bankruptcy Code. Although the term "claim" is defined very broadly, purely equitable remedies are not "claims" under the Code. However, under §101(5)(B), a right to an equitable remedy is a "claim" within the meaning of the Bankruptcy Code if a monetary payment is an alternative for the equitable remedy.

Moreover, the debtor could not preserve her right to reinstatement by limiting her recovery to equitable relief. Allowing her to do so would have granted her the equivalent of a preference over other creditors who had claims for monetary damages only or who agreed to accept liquidated damages for their equitable claims, by allowing her to avoid the prioritization of claims established in the bankruptcy proceeding.

Rederford v. U.S. Airways, Inc., 2009 U.S. App. LEXIS 27258 (1st Cir. 2009)

Anti-Modification Provision Inapplicable to Lot Encroaching Residence

The Bankruptcy Code's protection of mortgage lenders against modification of claims secured by a principal residence did not apply where a debtor's residence only encroached on his mortgaged property by a small amount.

The debtor resided in a house that straddled the property line between two lots. The majority of the house sat on one lot, but the house's street address was that of the other lot. When the debtor filed his Chapter 13 petition, he claimed both lots as assets.

The mortgagee filed a proof of claim for the full value of the mortgage on the property, and the debtor objected and moved for determination of secured status. Also, as part of his proposed Chapter 13 plan, the debtor sought to bifurcate the mortgagee's claim, and the mortgagee objected. The bankruptcy court allowed bifurcation of the claim, and the district court affirmed.

On appeal, the U.S. Court of Appeals for the First Circuit held that, if the mortgagee's claim was secured by the debtor's principal residence, then the claim could not be modified by bifurcating it into secured and unsecured claims, even though the value of the land is roughly one-tenth of the value of the claim. However, in this case the encroachment was minimal—the eight to 10 foot encroachment of the house onto the mortgaged property was not the principal part, or even an important part, of the residence.

In re LaFata, 2007 U.S. App. LEXIS 7610 (1st Cir. 2007)

Postpetition Increase in Income Not Subject to Means Test

A New Hampshire bankruptcy court recently held that consideration of postpetition developments in the application of the means test under Bankruptcy Code Sec. 707(b)(2) would be contrary to Congressional intent. Consequently, the court refused to dismiss the debtors' Chapter 7 bankruptcy case even if a postpetition increase in the debtors'income created a presumption of abuse.

The means test was intended by Congress to be applied to the debtors' financial circumstances on the petition date. To the extent that the trustee or the court wished to consider postpetition changes in those circumstances, the totality of the circumstances test of Sec. 707(b)(3) had to be applied. The court then accurately summarized the interplay between sections 707(b)(2) and 707(b)(3): the former creates a mechanical formula for presuming abuse whereas the later section of the Code bestows upon the bankruptcy courts the ability to consider circumstances, including postpetition developments, in determining abuse.

At the time of the meeting of creditors, the Chapter 7 debtors decided that they could no longer keep their home that was currently in foreclosure and had moved out of the home. Nonetheless, the bankruptcy court determined that the debtors could "deduct the amounts scheduled as contractually due" regardless of their intent with respect to retention of the collateral, reaffirmation, or actual payment of the secured debt. Section 707(b)(2) does not refer to the debtors' statement of intention and requires the debtors, the trustee, and the court to consider only the amounts due under the contracts themselves.

In re Hartwick, 2007 Bankr. LEXIS 476 (Bankr. D. NH. 2007)

Petition Date Determines Lien Avoidance

In In re Wilding, 475 F.3d 428 (1st Cir. 2007), the First Circuit U.S. Court of Appeals ruled that a debtor may avoid a judicial lien even if the lien is satisfied prior to filing a motion to avoid, so long as the lien in question impaired an exemption as of the bankruptcy petition date. The debtor received a discharge without seeking to avoid a judicial lien on his homestead. Sometime later when the debtor sought to refinance his home he asked the bankruptcy court to reopen his case so he could avoid the lien; however, the debtor satisfied the lien before the court could rule on the motion. Nonetheless, the court reopened the case and denied the motion because the lien no longer impaired the debtor's homestead exemption. The 1^st Circuit reversed, finding that it did not matter whether the lien still impaired the debtor's homestead exemption, only that the lien impaired the homestead when the debtor filed for bankruptcy.

Repeat Filing Does Not Terminate Stay

Noting a split of authority and following what it characterized as the majority view, the Bankruptcy Appellate Panel for the First Circuit that Section 362, which terminates the automatic stay on the 30th day after the filing of a debtor's second bankruptcy petition terminates the stay only with regard to the debtor and the debtor's property, not with regard to estate property. In so ruling, the BAP held Congress to its words in applying the newly-created 30-day stay to repeat filers.

Congress amended Section 362 to provide that when a debtor has been in a prior case dismissed within a year of the present filing, the stay terminates "with respect to the debtor" on the 30th day after the filing date. "Property of the debtor" is generally something different that "property of the estate," and, Section 362 seems to make distinctions between property of the debtor and property of the estate and the effect of the stay as to each.

The BAP observed that a complete termination of the stay would make sense, but that is not what the statute provides. Congress used different language in Section 362(c)(4)(A) in describing what happens to multiple repeat filers (debtors who have more than one prior case dismissed in year prior to the current case), where it says that "the stay under subsection (a) shall not go into effect." Section 362(c)(3)(A) unambiguously terminates the stay only as it protects the debtor. While this is a lesser penalty than complete termination, the panel found that a literal reading of the statute is consistent with Congressional intent to discourage abusive filings.

Jumpp v. Chase Home Finance, L.L.C., 2006 Bankr. LEXIS 3504 (Bankr. 1st Cir. 2006)

2nd Circuit

Law Firm without Standing to Challenge "Mary Carter" Agreement

A law firm that was a potential debtor of a Chapter 11 debtor's former CEO did not have standing to challenge the validity of a settlement agreement entered into between the CEO and the estate's unsecured creditors, the U.S. Court of Appeals for the Second Circuit held in In re Teligent, Incorporated, 2011 U.S. App. Lexis 9451 (2nd Cir. May 5, 2011). The settlement agreement gave the debtor a financial interest in the CEO's legal malpractice case against the law firm. However, the law firm did not have a financial stake in the outcome of the bankruptcy case. As a potential debtor of the bankruptcy debtor's former CEO, the firm's interest was too remote for it to be considered a party in interest in the bankruptcy case.

The debtor made a loan to its then CEO that would become payable if the CEO left the company without "good reason" or if he was terminated for "cause." When the CEO planned to leave the company, he hired the law firm to draft a severance agreement. The agreement provided that the debtor terminated the CEO for reasons other than for cause and that the unpaid balance of the loan was forgiven.

The debtor then filed for bankruptcy under Chapter 11, and the law firm hired to represent the estate's unsecured creditors filed an adversary proceeding in connection with the severance agreement. The bankruptcy court found that the CEO resigned before he was terminated and, therefore, he was responsible for paying the balance of the loan. The firm representing the debtor's creditors also filed suit against the CEO alleging that he had fraudulently transferred assets to his wife.

The CEO settled the lawsuit with the estate's unsecured creditors. The settlement agreement provided that the CEO would file a malpractice suit against the law firm that drafted the severance agreement and that half of any judgment received would be turned over to the debtor's unsecured creditors. In addition, the firm representing the creditors argued that the law firm that drafted the severance agreement was estopped from challenging the validity of the settlement as a defense in the malpractice case because the firm did not participate in the mediation that led to the settlement agreement.

However, the law firm was not a party in interest in the bankruptcy case and, therefore, did not have standing for purposes of being heard by the bankruptcy court on the settlement agreement's approval. The law firm did not have a financial stake in the outcome of the bankruptcy case. The firm was a potential debtor of the bankrupt's debtor, its former CEO, and, consequently, the firm's interest was too remote for it to be considered a party in interest in the debtor's bankruptcy case. Because the law firm did not have standing before the bankruptcy court to challenge the terms of the settlement agreement, it was not estopped from challenging the validity of the agreement in the malpractice action.

Child Tax Credit Not Exempt

A debtor was not permitted to retain the portion of a tax refund that was attributable to the federal child tax credit. After the debtor received federal and state tax refunds, the bankruptcy trustee sought turnover of the nonexempt portion of the tax refunds. The debtor amended her bankruptcy schedules and claimed a $2,500 exemption in the refunds. In addition, she turned over $3,000 to the trustee, after subtracting $2,500 for the exemption and $1,000 for the federal child tax credit.

The debtor argued that the child tax credit constituted a trust fund, with the debtor's child as the beneficiary. However, the debtor's argument was not supported by legislative history. If Congress intended the child tax credit to be held in trust for the benefit of the child and exempt from the parent's creditors, it could have enacted bankruptcy legislation to this effect.

In addition, the debtor had already obtained the advantage of the entire child tax credit when she used the credit to reduce her tax liability. Consequently, she was not entitled to use the credit again to insulate part of the tax refund from her creditors. Although the debtor did not file her tax return until after the petition date, her contingent interest in the child tax credit existed as of the petition date because all she needed to do to claim the credit was file her tax return.

In re Parisi, 2010 Bankr. LEXIS 1530 (BankrEDNY)

Inchoate Interest in Life Insurance Not an Asset of the Estate

An inchoate interest held by a spouse beneficiary in a reciprocal life insurance policy did not constitute an asset of the beneficiary's estate. Therefore, the bankruptcy trustee could not administer the cash surrender value of insurance policies of married debtors each held for the benefit of the other.

Although Bankruptcy Code Sec. 302 allows spouses to file jointly, it does not automatically consolidate their estates. Consequently, the trustee may not reach assets in a joint filing that he could not reach had the spouses filed separately. In this case, had the debtors filed separate petitions, the trustee would have been powerless to administer the cash surrender value as part of the estate of the owner/insured because state law provided an express exemption in favor of the beneficiary. Thus, any leviable interest in the property belonged to the owner/insured, not to the beneficiary; however, state law protected the cash surrender value from the creditors of the owner/insured.

Wornick v. Gaffney, 2008 U.S. App. LEXIS 20221 (2nd Cir. 2008)

Deduction Allowed for Collateral to be Surrendered Post-Petition

Payments on secured debt are proper deductions under the "means test," even if the debtor proposes to surrender the collateral post-petition. The means test calls for a snapshot of the debtor's obligations on the petition date. The debtor's stated intent to surrender collateral did not change the fact that the relevant secured debt was extant on the petition date. In addition, the debtor's statement of intention was not a self-effectuating document; it was not an actual surrender, only a statement by the debtor of his or her intent to surrender the collateral in the future. In re Longo, 06-30781, (Bankr. D. Conn. 2007)

"Hanging Paragraph" Does Not Protect Negative Equity Debt

The hanging paragraph of Section 1325(a) does not protect claims secured by automobiles that are purchased for personal use within 910 days pre-petition if the loan was for more money than the car was worth. In In re Jackson, 2007 Bankr. LEXIS 43 (Bankr. W.D.N.Y. 2007), the unpaid balance of the debtor's trade in was added to cash price of the new automobile. The debtor's plan treated the lender's claim as secured only to the extent of the new car's retail value, which was less than the loan amount.

The creditor objected to confirmation of the debtor's plan, arguing that the hanging paragraph added to Section 1325(a) entitled it to full payment. However, the protection afforded by the hanging paragraph for 910 vehicles applies only to claims secured by a purchase money security interest. Consequently, the creditor was not entitled to full payment because a portion of the loan was for refinanced debt.

3rd Circuit

Insurers Have Standing to Object to Creation of Mass Tort Trust

In In re Global Industrial Technologies, Inc., et al., 2011 U.S. App. Lexis 9109 (3rd Cir. May 4, 2011), the U.S. Court of Appeals for the Third Circuit ruled that liability insurers had standing to object to the creation of a mass tort settlement trust by Chapter 11 debtors' reorganization plan even though the insurers' ultimate liability was contingent. While the insurers had coverage defenses available to them, their liability was not so speculative as to deprive them of standing. The creation of the mass tort trust significantly increased the insurers' prepetition liability exposure; therefore, the insurers had a legally protected interest that would be affected by the debtors' bankruptcy case. Moreover, the insurers' allegations of collusion between the debtors and attorneys representing tort claimants were warranted. Consequently, recognizing the insurers' bankruptcy standing was particularly appropriate because their objections to plan confirmation implicated the integrity of the bankruptcy process.

Tort Claims

The debtors were manufacturers of refractory products whose Chapter 11 bankruptcy resulted from a large number of asbestos-related claims. The debtors also had a class action pending that involved 169 silica claims.

An asbestos trust was established as part of the debtors' proposed reorganization plan. The plan also created a silica trust where silica-related claims would be channeled. Both trusts were to be funded by the debtors' liability insurance carriers.

Plan Approval

The debtors needed to obtain the approval of 75 percent of the asbestos claimants in order for the plan to relieve them of their asbestos-related liability. In addition, the debtors were required to show that the plan's resolution of silica-related claims was fair and necessary for reorganization. The debtors contacted attorneys representing asbestos claimants to solicit approval of their proposed plan. The debtors also obtained a list of silica claimants from an unrelated bankruptcy case and solicited confirmation votes from those claimants' attorneys, many of whom also represented asbestos-related claimants. As a result of the debtors' efforts to solicit approval of their plan, silica-related claims rose from 169 prepetition claims to over 5,000.

Objection to Confirmation

The insurers objected to confirmation of the debtors' plan, arguing that the silica trust was the product of collusion with asbestos claimants' counsel. The insurers also questioned the validity of silica claims because most of them had been diagnosed by physicians previously deemed "not credible" in other silica litigation.

"Insurance Neutral" Plan

The bankruptcy court ruled that the insurers did not have standing to object to plan confirmation because any potential financial harm arising from confirmation of the plan was too speculative. While the insurers would provide funding for the trust, they could still assert their coverage defenses if called upon to reimburse the trust for silica-related claims. In other words, the plan was "insurance neutral" because it preserved the insurers' coverage defenses.

Standing to Object

A party must have bankruptcy standing to object to the confirmation of a reorganization plan. To have bankruptcy standing, a party must first meet the requirements for Article III Constitutional standing. The standard for constitutional standing is met as long as a party alleges a "specific, identifiable trifle of injury;" in other words, an injury in fact. Standing in bankruptcy cases is further governed by Bankruptcy Code Sec. 1109(b), which permits a party in interest to be heard on any issue in a case. Harmonizing Article III and Sec. 1109(b), the Third Circuit held that a party affected by a Chapter 11 proceeding has bankruptcy standing to appear and be heard; and an injury that is contingent is not necessarily too speculative for standing purposes.

In this case, the creation of the silica trust resulted in a "staggering" increase in the insurers' prepetition liability exposure. Thus, the plan was not "insurance neutral." Even though the insurers' ultimate liability was contingent, the plan's adverse effects were not too speculative: The significant increase in silica-related claims constituted a tangible disadvantage to the insurers despite the availability of their coverage defenses, including new administrative costs and litigation costs to ferret fraudulent claims.

Timely Notice of Appeal Jurisdictional Requirement

A district court did not have subject matter jurisdiction to consider an untimely appeal from a bankruptcy court's dismissal of a Chapter 11 debtor's petition, held the U.S. Court of Appeals for the Third Circuit. The untimely filing of the notice of appeal by the debtor was a jurisdictional defect that deprived both the district court and the court of appeals of subject matter jurisdiction to consider the merits of the bankruptcy court's dismissal of the debtor's case.

After the debtor's case was dismissed for cause by the bankruptcy court, the debtor sent a notice of appeal to the district court by regular and electronic mail. The notice was timely, but the filing of the notice of appeal with the district court was not.

The trustee did not object to the untimely notice; however, the district court sua sponte dismissed the appeal because the debtor failed to comply with Bankruptcy Rule 8006, which requires a petitioner to designate items to be included in the appellate record and a statement of relevant issues. The debtor appealed the district court's dismissal to the Third Circuit. The trustee moved to dismiss the appeal on the basis that the notice of appeal from the bankruptcy court to the district court was untimely and, therefore, the district court did not have subject matter jurisdiction over the case; and, if the district court lacked jurisdiction, so did the Third Circuit.

Requirements contained in the Bankruptcy Rules alone are not jurisdictional. A court's jurisdiction to consider appeals from bankruptcy court decisions is governed by 28 U.S.C. §158(c)(2). However, although 28 U.S.C. §158(c)(2) gives courts jurisdiction over bankruptcy appeals, the statutory provision also specifies that the time within which an appeal must be taken is the time specified in Bankruptcy Rule 8002. Consequently, the 10-day (now 14-day) requirement is jurisdictional because even though a bankruptcy rule specifies the time within which an appeal must be filed, the statutory incorporation of that rule renders its requirement statutory.

In re Caterbone, 2011 U.S. App. LEXIS 6782 (3rd Cir. 2011)

Inherited IRA Protected in Bankruptcy

An inherited IRA may be claimed as exempt under Bankruptcy Code Sec. 522(b)(3), a Pennsylvania bankruptcy court recently determined because, like an ordinary IRA, the funds were deposited in the original custodial account as retirement funds and, as such, they were exempt from federal taxation until the funds were withdrawn.

The IRA was funded by the debtor's mother. The funds being held for the debtor's benefit were transferred by the custodian to an inherited IRA account that listed the debtor as the beneficiary. Because the account was an inherited IRA, the bankruptcy trustee raised an objection, asserting that the funds were not exempt under the Bankruptcy Code or under state law. The state statute exempted "any retirement or annuity fund" from process if it was "provided for" in specified sections of the Internal Revenue Code (IRC).

In order to protect individuals in states that had opted out of the federal exemption scheme, the exemption provisions of Sec. 522(b)(3) were added by BAPCPA in 2005 to include retirement funds to the extent that the funds were in an account exempt from taxation under specified sections of the IRC, without a determination of whether the funds were "reasonably necessary for support of the debtor or the debtor's dependents." This subparagraph protects retirement funds to the same extent that they are protected under the federal exemptions, specifically Sec. 522(d)(12) as incorporated by Sec. 522(b)(2). This increased protection is afforded not only to an IRA account created by the debtor, but also extends to accounts that are transferred directly between trustees (e.g., inherited accounts) and to roll-over distributions.

Section 522(d)(12) requires that the account be comprised of retirement funds, but it does not specify that they must be the debtor's retirement funds. The distinctions made by the trustee between the tax treatment of inherited IRAs and ordinary IRAs, while accurate, were not significant. Both types of accounts are exempt from taxation, which is all that is required by Sec. 522.

In re Tabor, 2010 Bankr. LEXIS 2051 (BankrMDPa)

Exemption Applied to Asset, Not Value Claimed by Debtor

A debtor who "signaled" her intention to exempt an asset by listing the property at the same amount in Schedules B and C is entitled to the property in its entirety, even if it is later discovered that the property has a higher value than the exempted amount.

The debtor listed as "business equipment" cooking tools she valued at $10,718 on Schedule B and claimed an exemption in the same amount on Schedule C. The bankruptcy trustee did not object to the exemption within the 30-day period set forth by Federal Bankruptcy Rule 4003(b).

The trustee later determined that the actual market value of the cooking tools far exceeded the amount reported by the debtor in her schedules. Nonetheless, the bankruptcy court denied the trustee's request to sell the tools for the benefit of the estate and give the claimed exemption to the debtor. The district court affirmed.

On appeal, the U.S. Court of Appeals for the Third Circuit held that it was too late to sell the asset. If the trustee doubted the debtor's valuation of her business equipment, he should have had the property appraised and sought a hearing under Rule 4003. But the trustee's failure to file a timely objection or take any action within the 30-day deadline rendered the property fully exempt.

In re Reilly, 2008 U.S. App. LEXIS 15395 (3rd Cir. 2008)

Lifestyle Relevant to Good Faith, But Not Determinative

A bankruptcy court may consider a debtor's income, expenses, and lifestyle as part of an assessment of good faith when deciding whether to dismiss the debtor's bankruptcy under Bankruptcy Code Sec. 707(a). The recent amendments to the abuse provisions of Sec. 707(b) do not impliedly preclude a court from considering such income-and-expense factors. But substantial income and a comfortable lifestyle, was insufficient to demonstrate bad faith in a recent case decided by the Third Circuit Court of Appeals.

A creditor in the debtor's bankruptcy argued that the debtors'; ability to repay their debts, especially considering their substantial income and lavish lifestyle. A bankruptcy court may consider a debtor's income and expenses, together with other factors in assessing good faith. But the court's ultimate finding of bad faith may not be based exclusively on a debtor's financial means; otherwise, dismissal would essentially be based upon a debtor's mere ability to pay.

The debtors did not scheme to conceal or misrepresent income, file misleading schedules, or engage in any other misconduct. On the contrary, the debtors were straightforward in their schedules and forthcoming with the court and their creditors. Moreover, the debtors did not time their filing to shield a future source of income, and the accrual of their debt to start a medical imaging company, which had a business plan and definite income projections, was not unreasonable. Therefore, the debtors' case was not the type of egregious situation that warranted dismissal for lack of good faith under Sec. 707(a).

In re Perlin, 2007 U.S. App. LEXIS 18461 (3rd Cir. 2007)

Right to Cure Lost Following Foreclosure Sale

Resolving a division between the New Jersey bankruptcy and district courts, the U.S. Court of Appeals for the Third Circuit ruled recently that a Chapter 13 debtor does not have the right to cure a default on a mortgage secured by the debtor's principal residence between the time the residence is sold at a foreclosure sale and the time the deed is delivered.

Since the enactment of Bankruptcy Code Sec. 1322(c)(1), New Jersey bankruptcy and district courts have disagreed over whether the subsection allows a debtor the right to cure a default on a home mortgage between the time when the residence is sold at a foreclosure sale and the time the deed is delivered. However, the phrase "a foreclosure sale that is conducted in accordance with applicable nonbankruptcy law" is not ambiguous; the phrase refers to the sale itself, not to the entire sale process. Moreover, New Jersey bankruptcy courts, foreclosure practitioners, statutes, procedural rules, and the state supreme court all treat the term "foreclosure sale" synonymously with "foreclosure auction." Therefore, a home is sold at a foreclosure auction, and the delivery of the deed is a ministerial act which does not affect the redemption rights of the parties.

The legislative history of Sec. 1322(c)(1) appears to support the court's ruling. That section was added to the Bankruptcy Code to make explicit that a debtor's right to cure a default on a mortgage secured by his or her principal residence continues at least until the foreclosure sale, and may continue beyond that date if state law provides additional cure rights. In other words, Congress enacted the subsection to establish a uniform time--the foreclosure sale--for expiration of a debtor's federal right to cure. Policy considerations also lend support to the court's ruling: setting the expiration of a debtor's right to cure at the foreclosure sale, as opposed to the delivery of the deed, ensures that the debtor receives notice of the impending sale and ample opportunity to protect his or her interests by filing a bankruptcy petition prior to the sale and exercising the right to cure.

In re Connors, 2007 U.S. App. LEXIS 18452 (3rd Cir. 2007)

Retroactive Annulment of Stay Proper in Light of Bad Faith

A bankruptcy court did not abuse its discretion by dismissing a debtor's bankruptcy case on grounds of bad faith and refusing to convert it from Chapter 13 to Chapter 7.

The debtor and her husband owned several corporations that sold "wander-control" patient monitoring systems to nursing homes. A creditor obtained a state court judgment against the couple. Three days after the state court judge announced that he would issue his judgment, but the day before he actually did so, the debtor filed her Chapter 13 bankruptcy petition. When the state court judge issued his rulings, it entered nine orders, including the judgment, assessment of sanctions against the debtor, an injunction that effectively froze the assets of the debtor's corporation, and a directive to appear for a contempt hearing for failure to appear in court for the rulings.

The next day, the debtor's husband withdrew funds from the debtor's corporation in violation of the court order. Not only did the debtor know of her husband's actions, but she used the money to pay her attorneys' fees. The creditor sought to dismiss the debtor's bankruptcy as filed in bad faith, and the debtor sought to avoid the state court orders against her as violations of the automatic stay. The bankruptcy court dismissed the debtor's bankruptcy case.

Abuse of Discretion

The debtor argued that the bankruptcy court abused it discretion by dismissing the debtor's bankruptcy case and refusing to convert it from Chapter 13 to Chapter 7; that actions taken in violation of the automatic stay were void ab initio and must be set aside; and that the bankruptcy court abused its discretion by retroactively annulling the automatic stay. However, the U.S. Court of Appeals for the Third Circuit determined that the bankruptcy court did not abuse its discretion by dismissing and refusing to convert the debtor's bankruptcy case. The court cited a number of factors that supported the lower court's finding of bad faith, including the fact that the debtor filed for bankruptcy after the state court announced that it would rule against the debtor on the fraudulent conveyance. The same factors that indicated that the debtor filed her Chapter 13 petition in bad faith would apply with equal force to her Chapter 7 filing.

Automatic Stay

Even though the state court violated the automatic stay by entering orders against the debtor, holding her in contempt, and incarcerating her, those violations were retroactively ratified by annulment of the stay. This approach was necessary to preserve the meaning of the term "annulling" in Bankruptcy Code Sec. 362(d). Despite the possibility that the creditor actively encouraged the state court's stay violation, the only effect of its refusing to ratify the state court action would be to reward the debtor for her attempted abuse of the bankruptcy system. A bankruptcy court has wide latitude to balance the equities when granting relief from the automatic stay, in this case concluding that the debtor's dilatory tactics outweighed the creditor's unclean hands in encouraging the state court's stay violation.

In re Myers, 2007 U.S. App. LEXIS 14717 (3rd Cir. 2007)

Debtors Not Entitled to Disposable Income Adjustment for Attorneys, Trustees Fees

Neither the bankruptcy trustee's commission nor Chapter 13 debtors' attorneys' fees could be deducted from the projected disposable income received by the trustee during the applicable commitment period, as provided by the debtors' modified plan. The trustee added onto the debtors' original "pot plan&" the amounts necessary for payments of attorneys' fees and trustee commission. However, Sec. 1325(b)(1) provides that all of a debtor's disposable income must be paid to unsecured creditors, leaving nothing for payment to other classes of creditors. Claims for attorneys' fees and the trustee's commission do not fall within the class of unsecured creditors.

Official Form B22C provides for a deduction of the trustee's commission from the debtors' available disposable income, thus a further reduction in the amounts to be paid to general unsecured creditors for the trustee's commission would amount to inappropriate double-counting. Form B22C does not make any reference to attorneys' fees and, while the omission may be unfortunate, it is binding on the court.

In re Amato, 2007 Bankr. LEXIS 836 (Bankr. D. NJ. 2007)

Circuit Addresses Effect on Marital Property

In two recent decisions, the Third Circuit Court of Appeals clarified the interplay between state property rights and Bankruptcy Code exemptions. In In re Brannon, Nos. 05-4600 & 05-5060 (3rd Cir. 2007), the court ruled that a spouse's "aggregate interest" in entireties property is not limited to half of the value of the property. While "aggregate interest" is not defined in the Code, bankruptcy does not sever a tenancy by the entireties, but leaves the tenancy's general characteristics in place, including the right of one tenant to act on behalf of both with respect to the whole of the entireties property. Limiting the exemption to 50 percent, as proposed by the trustee, would restrict each spouse's rights to act with respect to the whole property. But the trustee is given no more authority than the authority given to creditors, and creditors may not "sever the unity of the tenancy."

In In re O'Lexa, No. 06-2254 (3rd Cir. 2007), a companion case to Brannon, the court held that a creditor may "sever the unity of the tenancy" only if both spouses are jointly liable on a debt. Thus, the debtor in O'Lexa was entitled to a general exemption in her family residence co-owned with her non-debtor husband as tenants by the entirety, even though the debtor incurred her debts for household expenses, which were necessaries under state law therefore could be collected from the debtor spouse alone or from the separate property of the non-debtor spouse. However, unless a debt is incurred by both spouses, a creditor may not execute on jointly-owned entireties property.

Confirmation Order Final Absent Showing of Fraud

In In re Szalinski, No. 06-22423 JAD (Bankr. W.D. Pa. 2006) a creditor's untimely objection to the treatment of its claim by a confirmed Chapter 13 plan was rejected. Despite having notice of the proposed treatment of its claim, the creditor did not file a timely objection to confirmation. Thus, in order to modify the terms of the debtor's confirmed plan, the court would have to amend or revoke its order of confirmation. However, the only ground for revocation is fraud, which was not present in this case. The court added that absent a showing of fraud or lack of notice, once a plan is confirmed, it may not be challenged on the grounds that it does not comply with a specific subsection of the Code.

4th Circuit

Denial of §707(b) Motion Final Order

A bankruptcy court's order denying a Sec. 707(b) motion to dismiss a Chapter 7 case as abusive was a final order that was immediately appealable to the district court, held the U.S. Court of Appeals for the Fourth Circuit. The determination of whether a Chapter 7 case is abusive is a mandatory threshold question, which, in effect, finally and conclusively resolves the issue of abuse. In addition, recognizing the finality of an order denying a Sec. 707(b) motion to dismiss maintains judicial economy, preserves estate assets, and better serves Congress' policy of having the issue of abuse determined at the threshold of a Chapter 7 case.

The debtors filed for Chapter 13 bankruptcy, which was later converted to a Chapter 7 case. The trustee filed a motion to dismiss the debtors' Chapter 7 bankruptcy as abusive under Bankruptcy Code Sec. 707(b). The bankruptcy court denied the trustee's motion. The trustee appealed to the district court, but the district court, holding that the bankruptcy court's order was not final, dismissed the appeal for lack of subject matter jurisdiction.

The Fourth Circuit reversed, holding that a denial of a motion to dismiss a case as abusive is not an interlocutory ruling but a final appealable order. The court observed that the nature of bankruptcy cases, which often involve many parties and protracted proceedings, justifies a pragmatic and less technical approach to determining the finality of orders; and orders that resolve a discrete issue within the larger bankruptcy case are immediately appealable.

Turning to the finality of orders resolving Sec. 707(b) motions, the court noted that the determination of whether a Chapter 7 case is abusive is a mandatory threshold question that must be resolved within a very short period of time. Unlike a motion to dismiss a case for "cause," where "cause" can arise at any time during the case, a motion to dismiss a case as abusive must be resolved at the outset of the case. Given the strict statutory deadlines and the gateway function of Sec. 707(b), an order denying a motion to dismiss as abusive, in effect, finally and conclusively resolves the issue. Recognizing the finality of Sec. 707(b) order is also consistent with the legislative purpose of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which significantly amended Sec. 707(b), to root out abusive bankruptcies and to promote a policy of repaying debts.

McDow v. Dudley, et al., 2011 U.S. App. LEXIS 23809 (4th Cir. Nov. 30, 2011)

Claim of Exemption Not Precondition for Lien Avoidance

A Chapter 7 debtor was not required to list her property as exempt in order to avoid a judicial lien that impaired the exemption, held the U.S. Court of Appeals for the Fourth Circuit. When considering the debtor's motion to avoid the lien, the bankruptcy court should have limited its focus on the hypothetical exemption that the debtor would have been entitled to in the absence of the lien. The plain language of Sec. 522(f) does not precondition the resolution of a lien avoidance motion on an actual claim of exemption by the debtor.

The debtor filed a motion to avoid a judicial lien on her home. The home was fully encumbered by a first mortgage on the property and so the debtor did not claim an exemption. Nonetheless, the bankruptcy court denied the motion based upon the debtor's failure to claim the exemption. The debtor appealed, and the district court reversed, concluding that the Bankruptcy Code does not require a debtor to actually claim an exemption in property subject to a judicial lien sought to be avoided under Sec. 522(f).

The Fifth Circuit affirmed the district court's ruling, adding that the district court's decision was correctly based on the plain language of Sec. 522(f). The circuit court also noted that the Code may not even permit a debtor to claim an exemption in property in which the debtor does not have any equity. The court rejected the judgment creditor's argument that allowing the debtor to file a motion to avoid its lien without listing an exemption for the encumbered property would deprive the creditor of an opportunity to objection to the debtor's exemption claim. The creditor could challenge the validity of the exemption during the hearing of the debtor's motion to avoid the creditor's lien. Or, if the debtor's motion to avoid is granted, the creditor could object when the debtor amends her schedules to claim the exemption that the creditor's lien had previously prevented.

Botkin v. DuPont Community Credit Union, 2011 U.S. App. LEXIS 11974 (4th Cir. June 13, 2011)

Plan Confirmed Despite Increase in Postpetition Charitable Contributions

When evaluating the charitable contributions of above-median Chapter 13 debtors, a court may only consider whether the contributions exceed the 15 percent cap imposed by Bankruptcy Code Sec. 1325(b), held the U.S. Bankruptcy Court for the Middle District of North Carolina. During the year prior to filing, the debtors made charitable contributions equal to just over three percent of their gross income. However, in their schedules, the debtors indicated that they would increase their future contributions closer to the 15 percent cap. Under the terms of the debtors' plan, unsecured creditors would not receive any payments.

The trustee objected to the confirmation of the debtors' proposed plan on the basis that the debtors were not contributing all of their projected disposable income to the payment of unsecured claims. The trustee argued that the debtors' contributions should be limited to their pre-filing amounts. If the debtors limited their future contributions to their pre-filing levels, the debtors' unsecured creditors would receive a dividend.

Confirming the debtors' plan over the trustee's objection, the bankruptcy court observed that the plain language of Sec. 1325(b) does not permit courts to consider when a debtor begins to make charitable contributions. The court's analysis is limited to whether the proposed contributions are within the 15 percent cap imposed by the Code.

In re Gamble, Dkt. No. 11-80131 (Bankr. M.D.N.C. June 15, 2011)

Trustee Authorized to Sell Home Subject to Tax Lien

A trustee was authorized to sell Chapter 7 debtors' home to satisfy an unavoidable federal tax lien despite the debtors' claim of exemption in the property, held the U.S. Bankruptcy Court for the Eastern District of North Carolina. The trustee proposed to sell the home for payment of the tax lien, administrative costs and unsecured claims. Administrative costs and unsecured claims would be paid from a 30 percent carve-out the IRS agreed to set aside from the net sales proceeds for the payment of costs and unsecured claims.

The debtors claimed an exemption in their home, which the bankruptcy court allowed, even though the debtors did not have any equity in the property. The debtors objected to the proposed sale, arguing that the trustee was not authorized to sell the property because based on the court's allowance of their exemption their home was not property of the estate.

Duty to Sell

A trustee's duty to sell property of the estate is subject to a debtor's allowed exemption in the property, but an allowance of an exemption only exempts the debtor's interest in the property, not the property itself. The debtors in this case did not have any equity in the property and, therefore, they did not have an interest to exempt from the estate.

Authority to Sell

Bankruptcy Code Sections 724(b) and 522(c) provide for exemption enforcement exclusion for unavoidable tax liens. This exclusion authorizes a trustee to sell property that is subject to an unavoidable tax lien despite a debtor's claimed exemption in the property. So the debtors in this case were not entitled to the payment of their claimed exemption, even if they had equity to exempt. Also, the carve-out for the benefit of unsecured creditors was a carve-out from the lien held by the IRS, not from a creditor who would be subject to the debtors' exemption claims.

In re Reeves, 2011 Bankr. LEXIS 875 (Bankr. E.D. N.C. 2011)

Chapter 13 Discharge Not Prerequisite for Lien Avoidance

Chapter 13 debtors were permitted to void a wholly unsecured lien on their residential property even though the debtors were not eligible for a discharge due to a prior discharge in Chapter 7. Adopting the minority view, the U.S. Bankruptcy Court for the District of Maryland ruled that the Bankruptcy Code did not condition the debtors' right to strip off a wholly unsecured junior lien on the debtors' discharge eligibility. Further, the anti-modification provision in §1322(b)(2) did not apply in this case because the creditor's lien was not a "secured claim" within the meaning of the Bankruptcy Code.

The debtors filed and received a discharge under Chapter 7 within four years of filing their Chapter 13 bankruptcy; therefore, the debtors were not eligible for a discharge under Chapter 13. However, since filing their Chapter 7 bankruptcy, the debtors' application for a loan modification had been denied and the debtors fell behind on their mortgage payments. Also, the debtors mistakenly believed that they could strip the junior lien in Chapter 7, but when they realized they could not, the debtors were unable to convert their case to Chapter 13 because they did not have sufficient income to fund a Chapter 13 plan.

The bank-lienholder argued that lien stripping in a Chapter 13 case following a Chapter 7 discharge is contingent upon the entry of a Chapter 13 discharge. While this may be the majority view, the court noted that the Bankruptcy Code does not condition lien avoidance upon discharge.

Bankruptcy Code Sec. 506 provides that a creditor has an allowed secured claim equal to the value of its collateral, and "allowed secured claims" are subject to the anti-modification provision of Chapter 13. However, to the extent that there is no value in the debtor's property to support the lien, the creditor does not have an "allowed secured claim." Of key importance the bankruptcy court observed is that the application of Sec. 506 is not contingent on discharge eligibility. In addition, the anti-modification provision in Sec. 1322(b)(2) does not apply to a wholly unsecured lien because the creditor's lien is not a "secured claim" within the meaning of the Bankruptcy Code.

Completion of Plan Payment

Nonetheless, the bank was protected in the event that the debtors' plan was not confirmed or if their case was dismissed prior to plan completion. In addition, confirmation of the debtors' plan was subject to the good faith requirement of Sec. 1325; however, under the circumstances, the bankruptcy court determined that the debtors' plan was proposed in good faith. After the debtors received their discharge, their mortgage modification was denied and additional mortgage arrears accrued. The debtors filed their Chapter 13 case to deal with the arrears and other new debt and to take advantage of the Chapter 13 lien stripping provisions. While the latter may be an indication of bad faith, in this case, the debtors were devoting all of their disposable income to fund their proposed plan and they had legitimate claims to be paid through their Chapter 13 plan. Further, the debtors did not have any non-exempt assets, and the lender whose junior lien the debtors proposed to strip would not receive any payment if it pursued foreclosure.

In re Davis, 2011 Bankr. LEXIS 1045 (Bankr. D. Md. 2011)

Pursuit of Fraudulent Transfer Violates Discharge Injunction

The pursuit of fraudulent transfer avoidance claims by unsecured creditors against a Chapter 7 debtor violated the discharge injunction because the creditors did not have lien or any other rights to the property transferred, ruled the U.S. Bankruptcy Court for the Eastern District of Virginia. The debtor transferred the property postpetition, and the creditors argued that the transfer violated the state's fraudulent transfer act. However, the postpetition transfer did not create an independent cause of action under the state act, only a remedy against the transferred property. Consequently, while the remedy the creditors were seeking was the avoidance of the postpetition transfer, the underlying claim was based on a prepetition judgment against the debtor that was discharged.

The debtor transferred parcels of real property postpetition, which the creditors alleged was done to put the property beyond their reach. After the debtor received her discharge, the creditors filed suit against the debtor and the transferees of the property in state court to avoid the transfers under the state's fraudulent transfer act. The debtor filed a complaint in the bankruptcy court to enjoin the state court action, arguing that the lawsuit violated the discharge injunction. The creditors argued that the lawsuit did not violate the discharge injunction because it was not based on their prepetition claims against the debtor, but rather the postpetition transfer of her property that they alleged was fraudulent. In other words, the creditors argued that the transfer itself created an independent postpetition cause of action against the debtor.

However, the state fraudulent transfer act did give the creditors a separate cause of action or claim against the debtor. The state act was remedial, and the creditors were pursuing the property for injury to their collections efforts, and not for any independent tort. Further, the creditors did not have any interest in the property that was transferred. To the contrary, they were pursuing rights that they possessed solely in their capacity as creditors holding prepetition claims against the debtor. Consequently, the creditors' fraudulent transfer claims against the debtor violated the discharge injunction.

Transferee Liability

The bankruptcy court determined that the discharge injunction did not prohibit pursuit of fraudulent transfer claims against the debtor's transferees. The discharge injunction does not invalidate prepetition claims; it only prohibits their enforcement against the debtor. With very limited exception, a creditor may pursue a claim against co-debtors, guarantors, or, as in this case, transferees of property fraudulently conveyed.

In re Rountree, 2011 Bankr. LEXIS 830 (Bankr. E.D. Va. 2011)

Unsecured Claim Survives Hanging Paragraph

The so-called "hanging paragraph" does not deprive an under-secured creditor of a deficiency claim, according to a recent ruling by the Fourth Circuit Court of Appeals. A debtor may surrender vehicle acquired for personal use within 910 days of filing for bankruptcy but he may not do so "in full satisfaction" if its sale yields less than the balance owed.

The debtor purchased a vehicle for personal use under a retail installment sales contract, and less than three months after purchasing the vehicle, the debtor filed for bankruptcy. In her repayment plan, the debtor provided for the surrender of the vehicle in full satisfaction of the debt she owed to the secured creditor even though the vehicle was worth less than the remaining balance of the underlying loan.

The Sec. 506 cram-down option is no longer applicable to debts owed for certain vehicles purchased within 910 days of filing for bankruptcy, and debtors must now pay the entire claim as filed. In other words, the claim is treated as fully secured. The majority of courts to analyze the issue have concluded that, by eliminating the application of Sec. 506 to 910 claims, the hanging paragraph ensures that such creditors are without a remedy to bifurcate their loans into secured and unsecured portions, therefore rendering their loans nonrecourse regardless of what the parties' contract allows.

The Fourth Circuit panel agreed that Congress unambiguously eliminated the 910 creditor's access to a federal remedy under Sec. 506(a). However, the court adopted the minority approach and held that, after a debtor satisfies the requirements for plan confirmation under Sec. 1325(a)(5)(C) by surrendering his 910 vehicle, the parties are left to their contractual rights and obligations. Thus, the creditor could pursue an unsecured deficiency claim under state law. Given the explicit language in the parties' contract, there was no dispute that the contract provided the creditor with a right to pursue a deficiency claim, and such contract was enforceable under Virginia law.

Tidewater Finance Company v. Keeney, 531 F.3d 312 (4th Cir. 2008)

No Tolling During Waiting Period Between Discharges

In Tidewater Finance Co. v. Williams, 2007 U.S. App. LEXIS 19474 (4th Cir. 2007), the Fourth Circuit Court of Appeals held that the mandatory period a debtor must wait to obtain a second Chapter 7 discharge is not tolled during the pendency of any intervening Chapter 13 bankruptcy filed by the debtor.

The debtor filed five bankruptcy petitions during an eight-year period. Her first petition was filed under Chapter 7 and the debtor received a discharge. The debtor later filed two Chapter 13 petitions, both of which were dismissed without discharge. Then, a creditor obtained a judgment against the debtor based on her default on an auto loan. Shortly thereafter, the debtor filed a third Chapter 13 petition, which was dismissed two years later.

The debtor filed her most recent petition prior to the effective date of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), which extended the waiting period from six to eight years. But even though more than seven years had passed since the debtor filed her first Chapter 7 bankruptcy, a creditor argued that the period set out in Sec. 727(a)(8) was "equitably tolled" during the debtor's three Chapter 13 proceedings. If the statutory period were tolled during the Chapter 13 proceedings for a total duration of more than two years, the debtor would not be able to obtain a second Chapter 7 discharge.

However, Sec. 727(a)(8) does not impose a limitations period or require a creditor to file a claim within a specified time period. Instead, the provision conditions the ability of a debtor to obtain a Chapter 7 discharge by requiring her to wait six (now eight) years after initiating earlier proceedings that ended in discharge.

In fact, the six-year period in Sec. 727(a)(8) does not commence when a creditor has a complete and present cause of action; it commences when the debtor initiates a bankruptcy proceeding, which may be well before the creditor has a complete and present cause of action. If Congress had intended to guarantee creditors six years of nondischargeability to enforce their claims, the statutory period would run from the accrual of the creditor's claim, instead of running from the initiation of a proceeding that may, as in this case, predate that claim.

Potential Loophole

The creditor also argued that the failure to toll Sec. 727(a)(8) would create a "loophole" in the Bankruptcy Code that would allow a debtor to receive a Chapter 7 discharge and then file, dismiss, and refile Chapter 13 petitions to take advantage of the automatic stay until six years have passed. However, Sec. 105(a) empowers bankruptcy courts to issue any order, process, or judgment necessary to carry out the provisions of the Bankruptcy Code and remedy attempted abuse. Additionally, Sec. 362 allows creditors to request relief from the automatic stay "for cause." BAPCPA amended the Code to restrict application of the automatic stay in cases of bad faith serial filers, and Sec. 349(a) allows a court dismissing a bankruptcy petition for "cause" to order that the dismissal of the petition bars the later discharge of any debts that could have been discharged in the initial proceeding. Therefore, bankruptcy courts have several options for warding off the "loophole" scenario presented by the creditor.

Potential Claimant Entitled to Notice

A wrongful death claimant who had not yet filed suit, but whose identity as a potential claimant was either actually known or reasonably ascertainable to the debtors, was a "known creditor" and, therefore, should have been given specific notice of the debtors' bankruptcy proceeding and the pertinent filing dates. An automobile accident in a construction zone operated by the debtor resulted in two fatalities.

Debtor's Knowledge of Potential Liability

The debtor became aware of the accident almost immediately, and short time later reported the incident to its liability insurer. The insurance company promptly assigned a claim number to the accident, hired accident reconstruction experts to investigate the incident, and retained legal counsel to represent it in the matter. Approximately one year after the accident, the debtor and its various subsidiaries filed for Chapter 11 relief. The estate of one of the victims of the car accident did not receive notice of the bankruptcy filing, the claims bar date, or the plan confirmation hearing.

Claimant a Known Creditor

The U.S. Court of Appeals for the Fourth Circuit held that the lower courts correctly determined that the decedent's estate was a known creditor at the time of the debtor's bankruptcy filing. While there is no bright-line rule applicable in determining whether a particular creditor is known or unknown to a debtor for constitutional notice purposes, a court should focus on the totality of the circumstances and evaluate whether a careful examination of its own books and records would alert a reasonable debtor to the possibility that a claim might reasonably be filed against it by a particular individual or entity. In the case at hand, the accident was extensive and tragic and, consequently, received significant coverage in local newspapers. The debtor not only saw these articles, but contributed to them. Additionally, the accident was reported by the debtor to its liability insurer as "an occurrence or an offense which may result in a claim."

In re J.A. Jones, Inc., 2007 U.S. App. LEXIS 15173 (4th Cir. 2007)

IRS Claim Not Satisfied by Property Not Actually Surrendered

Chapter 13 debtors' proposal to surrender personal property that the IRS could not levy without resorting to litigation did not constitute a "surrender" within the meaning of Bankruptcy Code Sec. 1325(a)(5)(C).

The IRS filed a notice of tax lien with respect to the debtors' tax deficiencies for the tax years at issue and perfected its security interest in all of the debtors' property. The debtors proposed a plan that attempted to invoke both the "cram down" and "surrender" options of Sec. 1325(a)(5). The debtors decided to surrender their clothing, jewelry and various household goods and requested that the IRS reduce its secured claim. The IRS rejected the debtors' proposed amendment to its claim arguing that it would be without any means of forcing the debtors to turn over the collateral securing its claim because the Internal Revenue Code exempted it from administrative levy. However, the IRS could seek judicial enforcement of its lien rights and convert the property to payment of its claim.

In the absence of actual delivery or turnover of the property to the IRS, the debtors would retain the very property they "surrendered" because the IRS would face substantial legal obstacles to collecting the property. While the term "surrender" is not defined, at the most basic level, surrender means relinquishment of all rights in the property, including the possessory right, even if such relinquishment does not always require immediate physical delivery of the property to another. If a secured creditor is legally foreclosed from immediately obtaining the property that a debtor proposes to surrender and the debtor does not in fact voluntarily relinquish all rights in the property, including the right to possession, then the debtor can in no way be said to have "surrendered" any of his rights in the property.

In re White, 2007 U.S. App. LEXIS 9237 (4th Cir. 2007)

Serial Bankruptcy Filing Triggers Automatic Stay as to Codebtor

The codebtor stay of Section 1301 barred a creditor from proceeding with a post-petition foreclosure sale of a debtor's residence, even though the automatic stay of Section 362 did not arise as a result of the debtor's repeated bankruptcy filings. The debtor filed her bankruptcy case seeking relief under Chapter 13, intending to stop a foreclosure sale of her home scheduled for later that same day. The debtor alerted the creditor of the bankruptcy filing but the creditor indicated that it would not stop the foreclosure sale because the debtor had filed two previous bankruptcy cases within a one year period (both cases having been dismissed) and, consequently, there was no automatic stay by virtue of Section 362(c)(4)(A)(i).

The debtor filed a motion to set aside the foreclosure sale, arguing that the sale was conducted in violation of the codebtor stay of Section 1301. The creditor contended that the effect of the debtor's repeat filings was that it prevented both the automatic stay and the codebtor stay from going into effect. Otherwise, the creditor argued, the "vitality of the codebtor stay is at the mercy of the status of the automatic stay." Nonetheless, the court found the terms of Section 362(c)(4)(A) unambiguous in that only the automatic stay of Section 362(a) is prevented from going into effect "when the factual predicate enumerated in Section 362(c)(4) exists. Section 362(c)(4)(A)(i) does not address the applicability of the codebtor stay that arises under Section 1301(a), and it certainly does not provide that the codebtor stay of Section 1301 does not come into effect if the circumstances of Section 362(c)(4) are met."

Further, the court found that, "nowhere in Section 1301(a) is the codebtor stay limited, qualified, or effected by Section 362(c)(4)." While the court could annul the codebtor stay, there was no indication that the debtor's repeat filings constituted abuse of the bankruptcy system. The dismissals of the debtor's two prior cases were due to filing deficiencies, at least some of which were attributable to her lawyer.

In re King, 06-15660, (Bankr. D. Md. 2007)

Nondischargeable Judgment Does Not Include Fees and Costs

In Barsh v. State of Maryland Central Collection Unit, 2006 Bankr. LEXIS 3529 (Bankr. D. Md. 2006), the bankruptcy court granted a discharge, which the debtor claimed included a judgment for a fine imposed by the state. While the fine itself was nondischargeable, the court's discharge order included attorneys' fees and other costs associated with the fine.

Following entry of the bankruptcy court's discharge order, the state sought a garnishment against the debtor's wages to satisfy the judgment. The debtor challenged the garnishment in both state court and the bankruptcy court. The state court entered a judgment first, finding that neither the fines nor the fees and costs owed by the debtor to the state were dischargeable.

The bankruptcy court had exclusive jurisdiction to determine the dischargeability of all claims against the debtor, including the judgment for the fine imposed by the state. However, after the bankruptcy case was closed, the state court having jurisdiction over the state's claim had concurrent jurisdiction to determine whether or not that debt was dischargeable.

The debtor, faced with a post-discharge collection action by the state, should have sought to remove the state court action to the bankruptcy court. Instead, the debtor permitted the state court to determine the dischargeability of the state's claim against him. As such, the debtor's contention that the state's claim had been discharged in bankruptcy was preclusively determined against him by the state court.

5th Circuit

Payments to IRS May Not Exceed Plan Term

A Chapter 13 plan proposing to "maintain" payments under Bankruptcy Code Sec. 1322(b)(5) on a secured claim for unpaid income taxes could not be confirmed, held the U.S. Court of Appeals for the Fifth Circuit, because the taxes were fully matured and payable before the debtor filed for bankruptcy. Section 1322(b)(5), which authorizes a debtor to "cure and maintain" payments on long-term debts, applies only to debts for which, by their original, pre-bankruptcy terms, the final payment is not due until after the end of a Chapter 13 plan's maximum term.

The IRS had a claim for unpaid taxes that was secured, in part, by the debtor's home. In his Chapter 13 plan, the debtor proposed to pay the IRS's secured claim in equal installments over a period of fifteen years. The IRS objected to confirmation because the proposed payment period was longer that the five-year term of the bankruptcy plan.

The bankruptcy court sustained the IRS's objection, and denied confirmation of the debtor's plan. The bankruptcy court held that Sec. 1322(b)(2) did not permit the debtor to modify the IRS's claim for unpaid taxes into a long-term debt and then cure and maintain that debt under Sec. 1322(b)(5). On appeal, the debtor argued that because the IRS's claim was secured by more than a lien on his home, he could modify the claim from a past due, lump sum debt into a long-term debt payable over a period longer than the Code-mandated term of five years.

However, a debtor may cure prepetition deficiencies and maintain future payments only if the original payment terms of the debt establish a final payment date after the conclusion of a Chapter 13 plan's statutorily mandated term. The IRS's claim for unpaid taxes was not a long-term debt, and tax debts do not have terms that allow for monthly payments. The debtor's taxes were fully matured and payable before the debtor filed for bankruptcy.

Pierrotti v. United States of America Internal Revenue Service (In the Matter of Pierrotti), 2011 U.S. App. LEXIS 12687 (5th Cir. June 22, 2011)

Debtor Not Protected from Job Discrimination

Private employers may reject potential employees based on bankruptcy status, the U.S. Court of Appeals for the Fifth Circuit held in a recent ruling. While the government is legally prohibited from refusing to hire someone based on their bankruptcy status, private employers are not subject to the same standard.

The debtor filed for bankruptcy under Chapter 13. The debtor was later offered a job, but the offer was rescinded when the employer found out about the debtor's bankruptcy. The debtor sued the employer under Bankruptcy Code Sec. 525(b), which prohibits private employers from discriminating with respect to employment against a debtor. The employer filed a motion to dismiss the case, arguing that Sec. 525(b) does not extend to hiring decisions. The bankruptcy court granted the employer's motion and the district court affirmed.

Public v. Public Employment

The debtor argued that refusing employment based on bankruptcy constituted "discrimination with respect to employment" within the meaning of Sec. 525(b). Bankruptcy Code Sec. 525(b) provides that "no private employer may terminate the employment of, or discriminate with respect to employment against" a person who filed for bankruptcy. Section 525(a), which prohibits employment discrimination by public employers is worded slightly differently than Sec. 525(b). Section 525(a) provides that the government may not "deny employment to, terminate the employment of, or discriminate with respect to employment against" a person who has filed for bankruptcy. When read together, the two subsections do not support the debtor's argument. Section 525(a) expressly applies to the denial of prospective employment but Sec. 525(b) does not. The omission, the appellate court reasoned, must be given effect, and the conclusion to be drawn from the omission is that Congress deliberately decided to omit "deny employment to" from Sec. 525(b), while including the prohibition for government employers.

In addition, Sec. 525 has been amended two times since its enactment, yet the disparate language of the two subsections has been left alone. When Congress includes particular language in one section of a statute but excludes it from another, it is presumed that Congress acted intentionally. Consequently, public employers may not discriminate against either existing or prospective employees based on their bankruptcy status, but private employers are only required to protect existing employees.

In re Burnett, 635 F.3d 169 (5th Cir. 2011)

Ownership Deduction Permitted Despite No Car Payment

Following the rationale of the Seventh Circuit in In re Ross-Tousey, 2008 U.S. App. LEXIS 25803 (7th Cir. 2008), the U.S. Court of Appeals for the Fifth Circuit has held that a debtor may claim a ownership expense on the means test even if the debtor does not have an automobile loan or lease payment.

The Fifth Circuit panel rejected the so-called "IRM approach," in which courts use the methodology of the Internal Revenue Manual (IRM) as an interpretive guide for applying the means test. Those courts look not only to the Local Standards, but also to how the IRS uses the Local Standards in its revenue collection process. Under the IRM, if a taxpayer has no car payment, the taxpayer is only entitled to the vehicle operation deduction, not the ownership deduction.

But the Fifth Circuit found that the plain language approach was more strongly supported by the language and logic of the statute. Under the plain language approach, the vehicle ownership deduction that applied to a debtor was the one that corresponded to his geographic region and number of cars, regardless of whether that deduction was an actual expense. In addition, Sec. 707(b)(2)(A) stated that "the monthly expenses of the debtor shall not include any payments for debts." That language was impossible to reconcile with the IRM approach, which would only allow the vehicle ownership deduction if the debtor had a monthly debt payment associated with the vehicle. Although the IRM approach provided a useful methodology for IRS agents for determining a taxpayer's ability to pay, there was no indication that Congress intended that methodology to be applied to the means test. It did not incorporate the IRM or the Financial Analysis Handbook into the statute or even refer to them.

In the Matter of Tate, 2009 U.S. App. LEXIS 12660 (5th Cir. 2009)

Auto Lender Entitled to Deficiency Claim in Bankruptcy

An auto lender could pursue a state court deficiency judgment against a Chapter 13 debtor who proposed to surrender the vehicle in full satisfaction of the lender's claim. Joining the Fourth, Seventh, Eighth, Tenth, and Eleventh Circuits, the U.S. Court of Appeals for the Fifth Circuit held that the "hanging paragraph" in Bankruptcy Code Sec. 1325(a) does not allow a debtor to surrender a "910 vehicle" in full satisfaction of his/her debt; instead, the remaining debt must be treated as an unsecured claim in the debtor's bankruptcy plan.

The Fifth Circuit acknowledged that BAPCPA has been criticized by some as being poorly drafted, but it cautioned against using such criticism as a license to invalidate the plain language of a provision. Additionally, the court noted the lack of any precise legislative history to elucidate Congress's intent with regard to the hanging paragraph. Nonetheless, the court asserted that where the Code does not supply a federal rule, a court can look to state law to determine parties' rights and obligations. A creditor's entitlements in bankruptcy arise in the first instance from the underlying substantive law creating the debtor's obligation, subject to any qualifying or contrary provisions of the Bankruptcy Code, and claims enforceable under applicable state law are allowable in bankruptcy unless they are explicitly disallowed. Accordingly, even though the "hanging paragraph" denied the creditor in the case at hand the use of Sec. 506 in pursuing its debt, it still had an unsecured debt it could pursue against the debtor under state law.

In the Matter of Miller, 2009 U.S. App. LEXIS 12185 (5th Cir. 2009)

Trustee Avoids Judicial Estoppel; Pursues Undisclosed Claim

A trustee was not judicially estopped from pursuing a personal injury claim that was not listed by debtors on their bankruptcy schedules. Judicial estoppel applies only against the party who takes an inconsistent position, namely a debtor; it does not apply against the trustee as the representative of innocent creditors.

The debtors were involved in a car accident with a vehicle driven by an individual who was acting in the course and scope of his employment. The debtor and his wife filed a personal injury suit in state court seeking damages from the employee, the employer and the employer's insurer. While the lawsuit was pending in state court, the debtors filed a Chapter 7 bankruptcy and failed to list their personal injury claim on their schedules.

After the debtors received their discharge, the defendant in the debtors' personal injury suit moved for summary judgment based on judicial estoppel. The debtors then reopened their bankruptcy case and removed the case to federal court so that the trustee could administer the previously undisclosed lawsuit and other undisclosed debts on behalf of the estate and the creditors. The trustee later sought to substitute himself for the debtors as the real party in interest in the lawsuit.

On appeal, the court found that the debtors' personal injury claim became an asset of their bankruptcy estate when they filed their bankruptcy petition. Moreover, the trustee became the real party in interest at that point and never abandoned his interest. The trustee reopened the Chapter 7 bankruptcy to pursue the debtors' personal injury claim for the benefit of the estate's creditors. The debtors stood to benefit only in the event that there was a surplus after all debts and fees were paid.

Kane v. National Union Fire Insurance Company, 2008 U.S. App. LEXIS 14904 (5th Cir.)

Creditor Had Standing Despite Abandoned Plan

A creditor had standing to file an adversary proceeding objecting to a Chapter 13 debtor's discharge. Approximately one year prior to his bankruptcy filing, the debtor borrowed money from the creditor and secured the loan with collateral consisting of a motorcycle, two shotguns, a pistol, a television, a VCR, and a riding lawnmower. The debtor's repayment plan provided for the surrender of the motorcycle to the creditor in full satisfaction of the loan. Several months later, the debtor's case was converted to Chapter 7. The creditor was listed as an unsecured creditor with a non-priority claim, However, the motorcycle was not listed as an asset. At the creditors' meeting, the debtor stated that he still owned the motorcycle, but that the shotguns belonged to his father and grandfather, and he no longer had the television or the riding lawnmower.

The creditor filed an adversary complaint alleging that, because the debtor did not own the shotguns given as collateral, the loan was obtained by fraud and false pretenses and, thus, the debt was not dischargeable under Bankruptcy Code Sec. 523. However, the bankruptcy court ruled that the creditor did not have standing to object to the debtor's discharge because confirmation of the debtor's modified Chapter 13 plan, under which the debtor was to surrender the motorcycle to the creditor in full satisfaction of his debt, was binding as to both parties. Therefore, when the case was converted to Chapter 7, the creditor did not have a claim against the debtor, secured or unsecured.

On appeal, the Fifth Circuit Court of Appeals determined that it would be unfair to bind the creditor to a Chapter 13 plan where the debtor abandoned the plan by exercising his right to convert from Chapter 13 to Chapter 7. In addition, the debtor testified that he still had the motorcycle. Thus, the debtor failed to fulfill his obligation under his Chapter 13 plan to surrender the motorcycle to the creditor in full satisfaction of his debt.

In the Matter of Dorsey, 2007 U.S. App. LEXIS 24784 (5th Cir. 2007)

Plan Payments Satisfy Security Interest in Property Rents

A lender with a security interest in rents from a Chapter 13 debtor's property was entitled only to payments under the debtor's plan in the amount necessary to satisfy its allowed secured claim. The lender argued that it was entitled to the payment of its claim plus the rents from the property. However, the lenders claim was limited by the Code to the value of its collateral, and allowing the lender to recover both rents and plan payments would impermissibly give the lender more than the value of its collateral.

In re Allen, 2006 Bankr. LEXIS 3629 (Bankr. S.D. Tex. 2006)

6th Circuit

Ability to Repay Warrants Dismissal

A Chapter 7 bankruptcy case for which the presumption of abuse under Bankruptcy Code Sec. 707(b)(2) did not arise was properly dismissed based on the debtors' high income level and excessive expenses, the U.S. District Court for the Northern District of Ohio held.

The U.S. Trustee moved to dismiss the debtors' case arguing that the case was abusive under Sec. 707(b)(3) because the debtors' income exceeded the median income of a similarly-sized family in the debtors' state of residence and a number of scheduled expenses were excessive or impermissible. Among the expenses scheduled by the debtors included college tuition and related expenses for their adult children. The essence of the trustee's argument was that the debtor's had the financial ability to repay some of their debts out of disposable income.

Granting the trustee's motion, the bankruptcy court determined that: (1) the debtors had the financial means to repay some of their debts; (2) the debtors were inappropriately paying for their adult children's education at the expense of their other creditors; and (3) the debtors' monthly mortgage payment was more than twice the housing allowance listed in the IRS National Standards for a similarly-sized family in the debtors' county of residence.

On appeal to the district court, the debtors argued that dismissal was not justified because they had "passed" the means test under Sec. 707(b)(2). They contended that the bankruptcy court improperly considered their ability to pay when the case was not presumed to be abusive under the means test. However, the means test is only a screening mechanism rather than a dispositive determination of abuse. The totality of circumstances may warrant dismissal even if the presumption of abuse does not arise or is rebutted. Among the factors to be considered is debtor's ability to repay debts out of future earnings and whether the debtor's expenses may be reduced significantly without depriving the debtor of adequate food, clothing, shelter and other necessities. A debtor's ability to pay can be the sole basis for a finding of abuse. But the bankruptcy court went beyond the debtors' high income to determine that allowing the debtors' to proceed under Chapter 7 would constitute abuse under Sec. 707(b)(3).

McGowan, et al., v. McDermott, 2011 U.S. Dist. LEXIS 21831 (N.D. Ohio 2011)

Tax Refund Received Postpetition Exempt

A trustee's objection to debtors' amended schedules to exempt tax refunds received postpetition and spent prior to the amendments was denied because the refunds were property of the estate on the petition date. Consequently, it was not "too late" for the debtors to exempt the refunds. In addition, the debtors' failure to list the anticipated refunds on their original schedules was not in bad faith nor was it an attempt to conceal the property from the trustee or creditors.

"Already Gone"

While the debtors did not list any tax refunds in their original schedules, they informed the trustee during the meeting of creditors that they expected to receive federal and state tax refunds. The debtors amended their schedules after the meeting to disclose and fully exempt the refunds.

The trustee objected to the amended exemption and filed a motion for turnover of the refunds, arguing that the amendment was "too late" because the refunds had already been spent. The trustee relied on other bankruptcy court decisions that seemed to suggest that tax refunds must be exempted before they are spent.

Property of the Estate

The bankruptcy court overruled the trustee's objection, denied his motion for turnover of the debtors' tax refunds, and rejected the argument that debtors cannot exempt a tax refund because it is "already gone."

Property of the estate is determined on the bankruptcy filing date, even if the property is not scheduled. Exemptions also are determined on the filing date, and an amendment to exemptions relates back to the date of filing. Consequently, if an asset is property of the estate at the time of filing, it can be exempted at any time prior to case closing.

The debtors' right to receive federal and state refunds was based on prepetition income. Therefore the refunds were property of the estate on the date of filing. Further, an asset that is exempt and is transferred postpetition may not be recovered by the trustee. However, whether a claimed exemption should be allowed when the trustee or other party objects, is determined under the totality of the circumstances.

Unusual and Chaotic Circumstances

A court may refuse to allow the exemption if the debtor acted in bad faith or concealed property from the trustee or creditors. However, the debtors did not act in bad faith nor did they attempt to conceal the tax refunds. The debtors orally disclosed the returns during their meeting of creditors. Also, they had virtually all of the federal wildcard exemption available at the time of filing. Even after the tax refunds were claimed as exempt, the debtors had most of their wildcard exemption remaining. Thus, the debtors were not trying to hide the refunds because the exemption was "maxed out."

While the debtors did not amend their schedules until 42 days after the meeting of creditors, the delay was justifiable. During the delay, the debtors lost their jobs, had to deal with serious family illness, and became homeless.

Prejudice

The trustee also argued that allowing the amended exemptions would prejudice the administration of the debtors' estate. However, a simple delay in claiming or amending an exemption does not constitute prejudice. Prejudice may arise when property is claimed as exempt after the trustee has begun to sell or has already sold the property, neither of which circumstances applied to the tax refunds in question. Further, the court may balance the prejudice to the debtor of disallowing the exemption against the prejudice to third parties in allowing it. In this case, the trustee expended minimal time and effort questioning the debtors about the tax refunds and corresponding with the IRS. The debtors disclosed the existence of the refunds during the 341 hearing. The debtors also had a large amount of their wildcard exemption available to exempt their tax refunds. Upon balancing the potential harms, the court held that the trustee had not adequately established the requisite prejudice that would result in the denial of the debtors' amended exemptions.

Attorney Sanctions

The trustee argued that the debtor's attorney should be held accountable for the delay in filing the amended exemptions. The court refused to hold the debtors' attorney accountable for the delay in amending the debtors' exemptions but cautioned counsel to have her future debtor clients disclose estimated tax refunds on the original schedules. The court declined to otherwise discipline the attorney under Rule 9011.

In re O'Brien, 443 B.R. 117 (W.D. Mich. 2011)

Earmarking Doctrine Does Not Shield Mortgage Recording

In In re Lee, the Sixth Circuit Court of Appeals, 530 F.3d 458 (6th Cir. 2008), affirmed an Eastern District of Michigan bankruptcy court ruling that avoided a late-perfected mortgage as a preferential transfer. The Chapter 7 debtor refinanced his original mortgage on his residence by obtaining a new loan from the same lender. The new mortgage was recorded and thus, under applicable state law, perfected 72 days after the closing of the new loan. Seventy-seven days after the new mortgage was recorded, the debtor filed a voluntary petition under Chapter 7.

The new mortgage was perfected well outside the 10-day grace period set forth in Bankruptcy Code Sec. 547(e), and the transfer of the debtor's interest in the property was made on account of an antecedent debt. Therefore, the transfer was avoidable; and the earmarking doctrine exception to preference liability did not apply to the transfer because the mortgagee refinanced its own loan and consequently was not a new creditor. Nonetheless, even if the mortgagee had been a new creditor, the earmarking doctrine would not have shielded it from preference liability because the new mortgage was not timely perfected, and the earmarking doctrine does not protect a late-perfecting refinancer from preference exposure.

Venue Transfer Mandatory

In a recent decision, the U.S. Court of Appeals for the Sixth Circuit held that a bankruptcy court may not retain a case filed in an improper venue over a timely objection by an interested party.

In consolidated cases, two sets of debtors, who were residents of the Northern Mississippi suburbs of Memphis, filed their bankruptcy cases in the Western District of Tennessee. The U.S. Trustee in the Northern District of Mississippi timely raised an objection and sought to dismiss or transfer the cases on the ground that venue was lacking because the debtors did not reside in the district, as required by 28 U.S.C. Sec. 1408.

The venue requirements of 28 U.S.C. Sec. 1408 are mandatory, not permissive. If a case is commenced in an improper venue, a court must dismiss the case or transfer it to a jurisdiction of proper venue if an interested party files a timely objection.

The appeals court also examined the interplay of Federal Bankruptcy Rule 1014(a)(2) and 28 U.S.C. Sec. 1408 and concluded that the former authorizes the transfer of an improperly venued case only to a district in which the case could have been brought originally. To the extent that there was any conflict between the Bankruptcy Rule and Sec. 1408, the statute trumped the rule.

Thompson; Jordan v. Greenwood, et. al., 2007 U.S. App. LEXIS 25975 (6th Cir. 2007)

Retirement Plan Loan Not a Debt

A retirement plan loan was not a "debt" under the Bankruptcy Code where the plan administrator did not have claim for repayment against either the debtor or his estate.

Prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), the majority of courts held that 401(k) loans were not "debts" under the Code, and because Congress did not explicitly say otherwise, the bankruptcy court in Eisen v. Thompson, 2007 U.S. Dist. LEXIS 47383 (BankrNDOhio 2007), presumed that "debt" retained its pre-BAPCPA meaning. Although Congress gave protection to 401(k) plans in bankruptcy by excluding contributions to retirement accounts from property of the estate under Sec. 541(b)(7) and exempting retirement accounts from property of the estate under Sec. 522(n), it did not add any amendments stating that 401(k) loans constituted "debts" or "secured debts".

In the absence of any evidence that indicated that the circumstances under which the debtor borrowed money from his retirement account was "special", a retirement plan loan or its repayment does not constitute a "special circumstance" under Bankruptcy Code Sec. 707(b)(2)(B)(i). Retirement plan loans are neither extraordinary nor rare and, without more, withdrawal of one's retirement funds could not be a special circumstance within the accepted definition of the term.

910 Creditors Entitled to Deficiency Claim

Two recent decisions from the Eastern District of Michigan hold that the hanging paragraph of Section 1325(a)(5) does not force a 910 creditor to accept surrender of its collateral in full satisfaction of the debt.

In re Hoffman, 2006 Bankr. LEXIS 3754 (Bankr. E.D. Mich. 2006); In re Particka, 2006 Bankr. LEXIS 3160 (Bankr. E.D. Mich. 2006)

7th Circuit

"Cramdown" Not "Fair and Equitable" Absent Allowance of Credit Bid

A Chapter 11 reorganization plan that would dispose of collateral free and clear of liens did not meet the "fair and equitable" requirement for a "cramdown," the U.S. Court of Appeals for the Seventh Circuit decided, because the plan did not provide for credit bidding by secured creditors. The debtors argued that the sale would give secured creditors the "indubitable" equivalent of their claims as required by Bankruptcy Code Sec. 1129(b)(2)(A)(iii). However, the sale of encumbered assets free and clear is authorized by Sec. 1129(b)(2)(A)(ii), and that section requires that secured creditors be given credit-bidding rights.

The debtors' plan proposed auctioning the debtors' assets to the highest bidder, free and clear of all liens, with the initial bid in each auction being supplied by a stalking horse bidder. The plan did not give credit-bidding rights to secured creditors. Thus, the creditors objected to confirmation of the debtors' plan on the basis that the proposal to sell their collateral "free and clear" was not fair and equitable as required by the Sec. 1129(b)(2)(A). Agreeing with the creditors, the bankruptcy court denied confirmation.

A cramdown sale of collateral is fair and equitable if the collateral is sold subject to the creditor's lien, the creditor is permitted to bid its credit at the sale, or the creditor receives the "indubitable" equivalent of its claim. Consequently, on appeal, the debtors argued that because the creditors would receive the proceeds from the sale of their collateral at auction, the proposed plan gave the creditors the indubitable equivalent of their claims.

However, the Seventh Circuit determined that Sec. 1129(b)(2)(A) does not authorize the confirmation of any plan as long as the plan satisfies the indubitable equivalence standard. Section 1129(b)(2)(A) lists three distinct ways to dispose of encumbered assets over a secured creditors objection. Therefore, a sale proposing to give a secured creditor the indubitable equivalent of its claim must be distinguished from the other types of sales covered by Sec. 1129(b)(2)(A).

A sale free and clear of liens is specifically covered by Sec. 1129(b)(2)(A)(ii). That section authorizes the sale of encumbered assets free and clear if the secured creditor is allowed to bid its credit at the sale. Therefore, a plan that proposes to sell encumbered assets free and clear must satisfy the requirements of Sec. 1129(b)(2)(A)(ii); otherwise, the general requirement of Sec. 1129(b)(2)(A)(iii)—that the creditor receive the indubitable equivalent—would render the specific requirement of Sec. 1129(b)(2)(A)(ii) meaningless. It also renders the section superfluous because any cramdown plan could be confirmed regardless of the sales method as long as the creditor receives the indubitable equivalent of its claim from the sale.

River Road Hotel Partners, LLC v. Amalgamated Bank, 2011 U.S. App. LEXIS 13131 (7thCir June 28, 2011)

Accounts Receivable Not Exempt Under State Garnishment Act

A state's wage garnishment act did not create a bankruptcy exemption for legal fees received by a debtor-attorney postpetition for prepetition work held the U.S. Bankruptcy Court for the Northern District of Illinois.

The fees were "wages" within the meaning of the state wage act, which exempts 85 percent of wages from creditor claims. However, the act could not be construed as creating a bankruptcy exemption.

The bankruptcy court observed that the state act places a temporary limit on how much of a debtor's wages may be taken by a judgment creditor before the wages are paid to the debtor. Once wages are paid, however, they are no longer subject to the act's limitations. The temporary nature of the act is not a characteristic typical of bankruptcy exemptions. Bankruptcy exemptions are permanent in so far as a debtor may forever sequester property from creditor claims.

In re Radzilowsky, 2011 Bankr. LEXIS 1673 (Bankr. N.D. Ill. May 6, 2011)

Status Hearing Violates Automatic Stay

An attorney who represented a debtor's former spouse in post-dissolution contempt proceedings to enforce the terms of a divorce settlement agreement willfully violated the automatic stay. The settlement agreement provided that the debtor would refinance the couples' home and remove the husband's name from the mortgage note.

The debtor was unable to refinance the mortgage; consequently, civil contempt proceedings were brought against the debtor in the state domestic relations court to ensure that the debtor followed through with her obligation to remove her ex-husband's name from the note. The debtor was also ordered to cure an arrearage on the mortgage. A status hearing was scheduled for a later date.

The debtor filed for bankruptcy before the scheduled status hearing. Despite the debtor's pending bankruptcy and a warning by the debtor's bankruptcy attorney that holding the hearing would violate the automatic stay, the hearing was held and further continued to a later date.

Claiming that she was harmed by the "numerous status dates," the debtor filed a motion for damages against her former husband's attorney for violation of the automatic stay. The attorney argued that the contempt hearing did not violate the automatic stay because it was not an attempt to collect a debt. However, the automatic stay applies to contempt proceedings, and the contempt hearing was continued for the ultimate purpose of ensuring that the mortgage arrearage was paid because the ex-husband could be held liable for the debtor's missed mortgage payments.

In re Hall-Walker, 2011 Bankr. LEXIS 573 (Bankr. N.D. Ill. 2011)

State Court Judgment Based on "Deceptive Act" Dischargeable

A prepetition decision by a state court that a debtor had committed a "deceptive act" under state law did not have collateral estoppel effect in the creditor's subsequent adversary proceeding against the debtor under Bankruptcy Code Sec. 523(a)(2)(A), held the U.S. Court of Appeals for the Seventh Circuit. The findings of the state court were entitled to collateral estoppel in the bankruptcy proceeding, however, the state court decision did not contain a finding that the debtor had the intent to defraud or deceive the creditor, which is a necessary element under Sec. 523(a)(2)(A).

The creditor hired the debtor to remodel her home. The parties did not execute a written contract. The creditor paid most of the agreed upon price for the remodeling, but the debtor walked off the job before all the work was completed because there was disagreement regarding the scope of the work to be performed. The creditor sued the debtor under the state's home improvements act, which, among other requirements, provides that a contract for home improvements must be in writing; and any person who violates the act commits a "deceptive act." Given that the parties failed to execute a written agreement, the state court found that the debtor had committed a "deceptive act" within the meaning of the state home improvement act.

Debtor's Intent

The state court never made a specific finding of fraudulent intent. The state court found that the debtor had committed a "deceptive act," but only because he violated the state home improvement act by not executing a written agreement. A finding of fraudulent intent is not even required for a violation of the state home improvement act. The state court also resolved any misunderstandings regarding the scope of the work to be performed by the debtor in the creditor's favor.

Collateral Estoppel

The creditor argued that collateral estoppel required a finding of nondischargeability in the debtor's bankruptcy case because a judgment under the state home improvement act constituted a "deceptive act." However, a finding of nondischargeability under Sec. 523(a)(2)(A) requires fraudulent intent, which does not necessarily equate to a "deceptive act" under the state home improvement act. After an evidentiary hearing, the bankruptcy court concluded that the debtor and creditor had different understandings as to what was included in the contract. The state court found that the creditor's understanding was the correct on. However, neither the state court nor the bankruptcy court found that debtor shared the same understanding of the contract and intended not to see it through, thus estabilishing the fraudulent intent required by Sec. 523(a)(2)(A).

In re Davis, 2011 U.S. App. LEXIS 4978 (7th Cir. 2011)

"Current Monthly Income" Calculation Includes Unemployment Benefit Payments

A Chapter 13 debtor was not permitted to exclude unemployment compensation received in the six months preceding his bankruptcy filing from the calculation of his current monthly income (CMI), an Illinois bankruptcy court recently held in In re Kucharz, 2009 Bankr. LEXIS 3451 (Bankr. C.D. Ill. 2009).

The debtor disclosed that he had received unemployment compensation totaling $1,230 during the six-month period preceding the bankruptcy filing, but claimed it was a benefit under the SSA that did not need to be included in the calculation of his CMI on Official Form B22C. Unemployment insurance, although paid through state-sponsored programs, has roots in the federal SSA. Nonetheless, the court determined that unemployment payments were excluded only if they were properly characterized as benefits received under the SSA. It was not sufficient that the benefits were merely "related to," "envisioned by," or "induced by" the SSA. More was required. Because the Bankruptcy Code's definition for CMI defines income as broadly as possible, the bankruptcy court determined that the ambiguity should be resolved in favor of including such benefits within CMI.

Transfers Not Avoidable Where Debtor Not Insolvent

Transfers made by an undercapitalized debtor prior to bankruptcy were not avoidable by the trustee because the debtor was not insolvent on the date of the transfers. The debtor had been a start-up company that purchased an aluminum manufacturing plant. Before the business began operating, the utility that supplied electricity to the plant paid the company to cease buying electricity from it for 16 months due to an electricity shortage. By the time the 16-month period ended, aluminum prices fell and electricity prices rose to a level where it was no longer feasible for the company to manufacture aluminum.

The trustee filed adversary actions in bankruptcy court against the debtor to recover several payments that the debtor had made within a four-year period prior to its bankruptcy filing.

Bankruptcy Code Sec. 544(b) authorizes a trustee in bankruptcy to avoid transfers made by a debtor that would be voidable under state law if made by an unsecured creditor. Under applicable state law, the t ransfer could be voided if the debtor was insolvent on the date of the transfer. Insolvency is defined by both Bankruptcy Code Sec. 101(32) and state law as having a balance sheet on which liabilities exceed assets.

At the time the company was formed, the balance sheet showed assets of $248 million and liabilities of $206 million. However, at the bankruptcy hearing, an expert in the valuation of companies testified that the debtor had contingent liabilities that were not included in the original balance sheet. He further opined that if the contingent liabilities were added back into the balance sheet, it would have shown liabilities of $367 million.

The court, like the lower courts before it, was not persuaded by the expert's opinion. It noted that contingent liabilities are not certain to occur and are often highly unlikely to ever become an actual liability. Because the expert treated the debtor's contingent liabilities as certainties, the court added, his expert opinion was invalidated. Finally, the court reasoned that the debtor knew it had to survive an initial period where its costs would exceed its revenues, and thus, it needed a capital cushion. The balance sheet demonstrated such a cushion. Therefore, the court held, the debtor was not insolvent at the beginning of the transfer period.

Baldi v. Samuel Son & Company, LTD., 2008 U.S. App. LEXIS 24058 (7th Cir. 2008)

Property Valued When It Enters Estate, Not When Petition Filed

For purposes of resolving a 522(f) motion, a bankruptcy court must value collateral as of the date that a debtor's interest in the property becomes part of the bankruptcy estate, according to the 7th Circuit Court of Appeals in In re Willett, 2008 U.S. App. LEXIS 19983.

While their case was pending, Chapter 13 debtors successfully moved to avoid a lien on their residence held by a judgment creditor. Despite the fact that the debtors' property had increased in value during the pendency of their case, the district court affirmed the bankruptcy court's conclusion that the debtors' property should be valued based upon the interest held by the debtors when they filed their petition.

Bankruptcy Code Sec. 522, Sec. 541, and Sec. 1306, concerning after-acquired property, dictate what becomes property of the estate and how it is valued. The debtors' case remained governed by the provisions covering property held by the debtors at the commencement of their action until the date that the property belonging to the estate changed from a remainder interest to a fee simple interest. When the debtors sought to avoid the lien, their interest in the property should have been valued at the fair market value of their fee simple interest at the time it was recorded.

Landlord's Removal of Tenant's Belongings Violated Stay

A landlord violated the automatic stay by removing a debtor-tenant's personal property from her apartment following her eviction. The landlord had notice of the debtor's bankruptcy and had an affirmative duty to deliver the debtor's personal property to the bankruptcy trustee. Bankruptcy Code Sec. 362(b)(22)'s exception to the automatic stay for evictions does not authorize a landlord to remove the personal property of an evicted tenant in bankruptcy. As a custodian of estate property of consequential value to the estate, the landlord had an affirmative duty to turn over the evicted tenant's property to the trustee.

Ward v. Edwards, 2007 U.S. Dist. LEXIS 75915 (NDIll Oct. 10, 2007)

Chapter 13 Audit-Related Fee Request Granted

The attorney for Chapter 13 debtors was granted an award of additional attorneys' fees from the bankruptcy estate for his representation of the debtors during an audit performed by the U.S. Trustee's (UST) office. However, the court granted an amount that it determined was reasonable for the legal services rendered.

The court in In re Moreland, 2007 Bankr. LEXIS 2103 (Bankr. C.D. Ill. 2007), ruled that the attorney's audit-related services were not already compensated by the $2,500 "no look" fee. The better course of action would have been to file an application for fees in advance for the purpose of rendering audit related legal services, and setting forth the proposed compensation and source of payment. The court determined that the audit was not complex and that a reasonable value of the legal services rendered for the audit was $400. The court granted the UST's objection to an award of costs.

Trustee May Not Administer Exempt Assets for DSO Creditor

Bankruptcy Code Sec. 522 (c)(1) did not give a bankruptcy trustee a valid basis with which to object to a debtor's claimed property exemptions or to administer otherwise exempt property for the benefit of a domestic support obligation (DSO) creditor. Exempt property is not estate property, and the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) does not allow the trustee to liquidate the exempt property for distribution to DSO creditors.

Otherwise exempt property does not lose its exempt status under Sec. 522(c)(1), and it is not property of the estate subject to administration by the Chapter 7 trustee. BAPCPA enhanced the rights of DSO creditors but conspicuously did not provide trustees with the additional duty or authority to liquidate exempt property for the benefit of a DSO creditor. Moreover, Sec. 507(a)(1), which raised domestic support obligations to first priority, simply provided the priorities for distribution of estate property. It does not grant authority of the trustee to liquidate exempt property. BAPCPA only amended Sec. 704, which outlines the duties of the trustee, to require a trustee to provide written notice to holders of DSO claims and to state child support enforcement agencies of their rights in collecting child support during and after the case.

In re Vandeventer, Jr., 2007 Bankr. LEXIS 1291 (Bankr. C.D. Ill. 2007)

Automatic Stay in Serial Case Terminates in its Entirety

A bankruptcy court for the Northern District of Illinois has joined the minority of courts limiting the duration of the automatic stay in its entirety to 30 days for a case filed within one year of the date on which a previous case was dismissed. When a bankruptcy case is filed, all property of the debtor becomes property of the estate unless it is abandoned, exempt, or excluded by definition. Interpreting Section 362(c)(3)(A) as terminating the stay only as to actions taken against the debtor or the debtor's property would render the provision inconsequential and lead to an absurd result in conflict with related statutory provisions, such as that providing for notice to all parties in interest of a motion to extend the stay.

In re Curry, 2007 Bankr. LEXIS 474 (Bankr. N.D. Ill. 2007)

Treatment of Secured Claim Unaffected by Future Intent

A debtor may deduct from the "means" test scheduled mortgage payments that are contractually due on the petition date even if the debtor intends to surrender the property. In the means test, Congress intended to create a mechanical test for establishing a presumption of abuse. Bankruptcy Code Section 707(b)(2) instructs debtors to deduct the amounts scheduled as contractually due in each of the 60 months following the date of the petition, without regard to whether the debtor intends to keep the collateral.

In re Randle, 2006 Bankr. LEXIS 3519 (Bankr. N.D.Ill. 2006)

Similar reasoning was embraced by the bankruptcy court for the Eastern District of Wisconsin, where the court held that the debtors could take a means test deduction for mortgage payments, even though they did not intend to reaffirm their mortgage debt. According to the court, the means test is intended to give a snapshot of the debtor's finances as of the petition date. Thus, any payments that the debtor is contractually obligated to make should be included in the means test. The court left open the possibility, however, that the debtor's Chapter 7 case could be dismissed as an abusive filing under Section 707(b)(3) based on the totality of the debtor's financial circumstances.

In re Nockerts, 2006 Bankr. LEXIS 3435 (Bankr. E.D.Wis. 2006)

8th Circuit

Transfer Pursuant to Settlement Agreement Subject to Avoidance

A bankruptcy court's ruling in favor of a Chapter 7 debtor's parents on a fraudulent transfer action, in which the bankruptcy court held that the debtor could not fraudulently transfer property that would qualify as exempt was reversed by the U.S. Bankruptcy Panel for the Eighth Circuit because the bankruptcy court failed to take into consideration the fraudulent transfer provisions under the Bankruptcy Code. The bankruptcy court determined that exempt property was not capable of being fraudulently transferred under applicable state law, and it extended this rationale to the fraudulent transfer provisions of the Code. However, state law determines the nature of a debtor's interest in property, but it does not determine whether a transfer of that interest is fraudulent under bankruptcy law.

The debtor and her then-husband entered into a contract for deed to purchase a home owned by the debtor's parents. The parents transferred their interest in the deed to a self-settled trust. The debtor and her husband maintained regular monthly payments, although they failed to make to balloon payments required by the contract. The debtor and her husband subsequently filed for divorce, after which the debtors' parents served a notice of cancellation of the contract for deed on the debtor and her husband and demanded payment of the outstanding balance due under the contract.

The debtor's former husband obtained a loan sufficient to purchase the property in his name alone, however, the debtor did not attend the closing nor did she execute the necessary documents. The debtor's husband then sued the debtor and her parents for unjust enrichment, fraud, conspiracy and other torts. The parties ultimately entered into a settlement agreement that required the debtor and her former husband to convey their interests in the property to the debtor's parents.

Less than one year after the transfer, the debtor filed for bankruptcy. Claiming that the transfer was constructively fraudulent, the trustee filed an adversary proceeding against the debtor's parents to avoid the transfer. The bankruptcy court dismissed the trustee's adversary proceeding, holding that because the transfer could not be avoided under state law, it could not be avoided under bankruptcy law.

The BAP reversed. While the nature and extent of the debtor's interest in property is determined by state law, Bankruptcy Code Sec. 548 establishes the elements of a fraudulent transfer in bankruptcy. The bankruptcy court should have considered those elements. Further, the debtor would not have been able to claim the property as exempt under the Code because she chose to transfer it to her parents. In addition, the parents were not entitled to the benefit of the exemption the debtor could have claimed had she not transferred the property to them.

Sullivan v. Welsh (In re Lumbar), 2011 Bankr. LEXIS 3839 (B.A.P. 8th Cir., Oct. 12, 2011)

Interest Acquired Through Subrogation Not Avoidable

A judgment creditor's lien on Chapter 7 debtors' vehicle could not be avoided because the creditor, in order to force the sale of the vehicle, was required by state law to pay off a bank's prior perfected security interest against the collateral. According to a federal bankruptcy court, the creditor became subrogated to the bank's rights, and the fact that the creditor obtained the bank's rights through the process of enforcing a judicial lien did not convert the bank's rights, which the creditor acquired, into a judicial lien.

The debtors won an automobile, which they pledged as collateral for two loans with the bank. The debtors also maintained an open account with the creditor. The creditor obtained a money judgment against the debtors, which it sought to enforce against the debtors' vehicle. The sheriff levied on the debtors' vehicle and the creditor, as required by state law, paid off the bank's interest. The debtors were current on their loan payments to the bank at that time. Before the creditor could sell the vehicle, the debtors filed for bankruptcy, claimed an exemption in the vehicle, and attempted to avoid the creditor's lien as an avoidable judicial lien under Bankruptcy Code Sec. 522(f)(1)(A).

The creditor objected to the avoidance of its lien, arguing that by paying off the bank loan it became subrogated to the bank's rights as a secured creditor. The debtors argued that even if the creditor's interest was converted from an avoidable judicial lien to a non-avoidable security interest, the creditor could not assert the default provision of the underlying security agreement and force the sale of their vehicle because the debtors were current on their loan payments to the bank.

The bankruptcy court determined that all of the bank's rights associated with its security interest became available to the creditor. Whether the creditor, as subrogee of the bank's rights, could force the sale of the vehicle absent a default in loan payments was not before the court to address. Nonetheless, the creditor assumed the non-avoidable security interest of the bank. The court also observed that it would be unfair to allow the debtors to avoid an otherwise non-avoidable security interest because the creditor paid the underlying loan in an attempt to collect against the debtors prepetition.

In re Carter, 2011 Bankr. LEXIS 4066 (Bankr. N.D. Iowa, Oct. 26, 2011)

Personal Property Entitled to Homestead Exemption

A Chapter 7 debtor was entitled to claim a homestead exemption for money in a savings account even though the funds had been commingled with proceeds from the sale of nonexempt property, held the U.S. Court of Appeals for the Eighth Circuit. The homestead exemption applies to proceeds from personal property sold with a debtor's home if, as in this case, the debtor uses the proceeds to maximize his homestead exemption.

After selling his homestead and paying off a first mortgage on the property, the debtor deposited the remaining sales proceeds into a savings account. The homestead sale included furnishings with an approximate value of $7,700.

The debtor subsequently filed for bankruptcy under Chapter 7 and claimed a homestead exemption for the total savings account balance. The trustee objected to the exemption claim with regards to the value of the home furnishings. The bankruptcy court sustained the objection, finding that the proceeds from the sale of the debtor's nonexempt personal property were not part of the homestead.

The U.S. Bankruptcy Appellate Panel for the Eighth Circuit reversed the bankruptcy court's decision, holding that the debtor had shown "sufficient indicia" of his intent to convert the nonexempt property into homestead property by depositing all proceeds from the sale into the same account. The court of appeals upheld the reversal of the bankruptcy court's decision, but noted that intent to convert nonexempt property into exempt homestead property alone is not enough-there must be an actual conversion.

Conversion of Nonexempt Property

Nonexempt property can be converted to exempt homestead property if proceeds from the sale of the nonexempt property are used to make an actual payment to the lien holder of the homestead, thus increasing the debtor's equity in the property. Therefore, the Bankruptcy Appellate Panel erred by requiring only "sufficient indicia" of an intent to convert nonexempt property to exempt property. The BAP also erred by "finding" that the debtor intended to convert nonexempt property to exempt property because findings of fact are the sole province of the bankruptcy court.

Nonetheless, a claimed exemption is presumptively valid, and the trustee failed to show that the debtor segregated the proceeds from the sale of the house from the proceeds from the sale of the furnishings or that only the proceeds from the sale of the home were used to pay off the mortgage. The funds the debtor used to pay off the mortgage came from a single pool of money that included proceeds from the sale of both the home and the furnishings.

In re Danduran, 2011 U.S. App. LEXIS 19078 (8th Cir. June 14, 2011)

Debtor's Trust Income Not Property of Bankruptcy Estate

A bankruptcy court did not err in finding that a trust's spendthrift provision restricting the transfer of trust assets was enforceable under state law and that a debtor's interest in income distributions was exempt from the bankruptcy estate despite the debtor's prepetition mishandling of trust assets in her capacity as executrix, held the U.S. Court of Appeals for Eighth Circuit. The debtor did not have the authority as beneficiary to alter the terms of the trust; consequently, her actions as executrix did not invalidate the spendthrift provision.

Prior to his death, the debtor's husband established a testamentary trust naming the debtor as the income beneficiary of the trust. The husband's will also appointed the debtor executrix of the probate estate and directed the debtor, in her capacity as executrix, to fund the trust by transferring securities to it. Rather than funding the trust, however, the debtor sold the securities and invested the proceeds in several failed business ventures. A new executor was later appointed by the state probate court and the trust was funded by the estate's remaining assets.

The bankruptcy trustee and the newly-appointed executor of the probate estate argued that the income generated by the trust was property of the bankruptcy estate. They contended that because the debtor, acting as executrix, exercised improper control over assets earmarked for the trust, the spendthrift provision was neither valid nor enforceable under state law, which recognized the validity of spendthrift provision only if the provision restricted both voluntary and involuntary transfers of the trust corpus by the beneficiary.

Affirming the bankruptcy court's ruling that the spendthrift provision was valid, the court of appeals observed that, as beneficiary of the trust, the debtor did not have the authority to alter the terms of the trust or to prevent the distribution of income. The debtor exercised control over probate assets as executrix; however, the debtor's actions as executrix were not sufficient grounds to deny her the benefit of the trust's spendthrift provision in her capacity as beneficiary.

The trustee and executor also argued that the debtor was equitably estopped from enjoying the benefits of the spendthrift provision as trust beneficiary when as executrix she mishandled the trust corpus. However, neither the trustee nor the executor presented any evidence that they had detrimentally relied on the debtor's misdeeds as executrix, an element that is required by the doctrine of equitable estoppel.

Wetzel v. Regions Bank, 2011 U.S. App. LEXIS 16629 (8thCir Aug. 12, 2011)

Debt Based on Unjust Enrichment Not Subject to Turnover

A Chapter 7 trustee's action to recover a debt based on unjust enrichment exceeded the scope of Bankruptcy Code Sec. 542(b), held the U.S. Bankruptcy Appellate Panel for the Eighth Circuit. The trustee argued that heirs of the debtor's deceased wife owed the bankruptcy estate rent for the debtor's care of cattle they had inherited. The bankruptcy court determined that the debtor was adequately compensated for pasturing and feeding the cattle and, therefore, the heirs were not indebted to the bankruptcy estate. The BAP affirmed on the more fundamental ground that Sec. 542(b) did not recognize unjust enrichment as a basis for collecting a debt.

The debtor inherited the couple's ranch from his wife and their children inherited her cattle. The trustee sued the children to recover as rent the costs to the bankruptcy estate of caring and feeding the cattle. According to the trustee, the children were unjustly enriched by the debtor's care of their cattle and that their debt to the debtor in the form of rent was property of the estate.

Debt Not Property of the Estate

The claim for rent was not property of the estate as the trustee had argued, and, therefore, the debt allegedly owed to the estate was not subject to turnover under Sec. 542(a). The rent, if any was in fact owed, for the debtor's care of the cattle was a debt owed to the bankruptcy estate, and claims for debts owed to an estate are governed by Sec. 542(b). That section applies only to debts that are "matured, payable on demand, or payable on order." The BAP observed that an action to collect a disputed debt based on unjust enrichment could not be characterized as any of those; consequently the trustee's action was beyond the scope of Sec. 542(b).

Lovald v. Falzerano (In re Falzerano), 2011 Bankr. LEXIS 1961 (Bankr8thCir Aug. 10, 2011)

Cases Converted to Chapter 7 Subject to Means Test

The means test created by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 applies to cases filed under Chapter 13 but converted to Chapter 7, the U.S. Bankruptcy Appellate Panel for the Eighth Circuit ruled. While the question of whether Sec. 707(b)(1) applies to converted cases is the subject of disagreement among bankruptcy courts, the BAP was bound by a prior decision by the U.S. Court of Appeals for the Eighth Circuit that held that the filing date of a converted case is deemed to be the date of the original filing.

Bankruptcy Code Sec. 707(b)(1) provides that a bankruptcy court may dismiss a case filed under Chapter 7 if the court determines that the granting of relief would be abusive. The question of whether Sec. 707(b)(1) applies to cases converted from Chapter 13 to Chapter 7 has caused disagreement among the courts. Some courts hold that Sec. 707(b)(1) applies only to cases that are filed under Chapter 7 because Sec. 707(b)(1) makes no reference to cases converted to Chapter 7, only to those "filed" under Chapter 7. However, other courts see the word "filed" in Sec. 707(b)(1) as identifying the type of debtor subject to the means test, rather than as a limitation of how the case arrived in Chapter 7, either by filing or conversion.

Despite competing interpretations of Sec. 707(b)(1), the Eighth Circuit in Resendez v. Lindquist, 691 F.2d 397 (8thCir 1982) held that when a case is converted from Chapter 13 to Chapter 7, the debtor is deemed to have filed a Chapter 7 case at the time the Chapter 13 was filed. Consequently, the BAP did not have to consider the proper interpretation of "filed" in Sec. 707(b)(1) because the debtor was deemed to have filed a case under Chapter 7 and, therefore, his converted case was subject to the means test.

In re Chapman, 2011 Bankr. LEXIS 748 (Bankr. 8th Cir. 2011)

Surcharge of Exempt Assets Not Within Court's Remedial Powers

A bankruptcy court did not have the authority to surcharge exempt property as a remedy for the debtors' failure to turnover nonexempt funds. When the debtors filed their Chapter 7 petition, they disclosed their ownership interest in a television show and reported that the interest produced a monthly income. They did not claim the income as exempt; yet, they did not surrender the income from the show to the trustee. After the debtors received a discharge, the trustee filed a motion to compel the turnover of income distributions from the show. The bankruptcy court granted the motion.

Despite the bankruptcy court's order, the debtors did not surrender any of the post-petition distributions. The trustee moved the court to surcharge the debtors' exemptions to cover the amount of the distributions plus interest, costs, and attorneys' fees. The bankruptcy court granted the motion to surcharge the debtors' exemptions pursuant to its equitable powers under Bankruptcy Code Sec. 105(a).

However, the bankruptcy court did not have the power, in the exercise of its authority to enter "necessary or appropriate" orders, to surcharge the debtors' exempt assets. While the debtors failed to comply with their turnover obligations under the Code and thus deprived the estate of other, nonexempt funds that could have been administered by the trustee, the surcharge was not consistent with other provisions of the Code.

The Code contains specific provisions governing exemptions and a limited number of exceptions to the rule that exempted property cannot be used to satisfy prepetition debts or administrative expenses. The enumerated exceptions do not include a surcharge of exempt property for failure to turn over estate property, and because the exceptions are explicit, a court cannot read additional exceptions into the statute.

The Code also contains specific remedies for a debtor's failure to turn over estate property to the trustee, such as denial of discharge, dismissal of the case, and revocation of discharge. In fact, the trustee in the case already commenced an adversary proceeding to revoke the debtors' discharge. The court was not at liberty to fashion a remedy outside of the existing statutory framework.

In re Scrivner, 2008 U.S. App. LEXIS 16850 (10th Cir. 2008)

Opt-Out Statute Provides No New State Exemptions

A bankruptcy court properly ordered tax refunds of Chapter 7 debtors to be turned over to the bankruptcy trustee. The Missouri opt-out statute did not permit the Chapter 7 debtors to exempt tax refunds from their bankruptcy estates. The opt-out statute was not an exemption statute and, thus, there was no exemption for tax refunds under state law or applicable federal law.

In consolidated bankruptcy cases, Chapter 7 debtors asserted that their state and federal income tax refunds were exempt from their bankruptcy estates based on the Missouri opt-out statute. The debtors interpreted the language of the statute to mean that any property that was not subject to attachment and execution under Missouri law was exempt from the estate. However, the opt-out statute announced no new exemptions under Missouri law. The statute simply provided that, where another Missouri statute specified that certain property was exempt from attachment and execution, then a debtor could exempt that property from the bankruptcy estate. Thus, the debtors' anticipated tax refunds, to the extent they were attributable to events occurring prior to the filing of the bankruptcy petition, were part of the bankruptcy estate.

In re Benn, 2007 U.S. App. LEXIS 16248 (8th Cir. 2007)

Applicable Commitment Period Is Temporal

A below-median Chapter 13 debtor was denied confirmation of her Chapter 13 plan because her plan would pay off her debts prior to the completion of the three-year applicable commitment period. The term "applicable commitment period" refers to the required duration of a Chapter 13 plan rather than the minimum amount a debtor must pay to unsecured creditors in order to get a discharge. Because the trustee objected to the plan, the debtor was not entitled to an early payoff, even though her creditors would receive the same return on their claims whether the duration of the plan was 36 months, or a lesser period.

In re Luton, 2007 Bankr. LEXIS 717 (Bankr. W.D. Ark. 2007)

Reasonable and Necessary Expenses Determined by Means Test

Projected disposable income for above-median Chapter 13 debtors is determined by the means test, according to a recent ruling by the bankruptcy court for the District of Nebraska in In the matter of Mitchell, 2007 Bankr. LEXIS 2 (Bankr. D. Neb. 2007). An unsecured creditor objected to confirmation of the debtor's plan because the debtor did not commit all of her projected disposable income to plan payments. Using figures from the Form B22C, the debtor had disposable monthly income of only $447 per month. However, Schedules I and J revealed that the debtor actually had monthly disposable income of nearly $3,000. Nonetheless, as an individual with above-median income, the debtor's disposable monthly income was determined by application of the means test rather than Schedule J.

9th Circuit

Viability of Informal Proof of Claim Doctrine Reaffirmed

An informal proof of claim was established by a creditor's motions for relief from the automatic stay and objections to plan confirmation, held the U.S. Bankruptcy Appellate Panel for the Ninth Circuit.

The Chapter 13 debtor scheduled three vehicles that he intended to surrender to the creditor. The creditor filed motions for relief from the automatic stay to repossess the vehicles. Each motion stated the balance of the loan as of the filing date of the motion and included copies of the underlying loan agreements and certificates of title. The motions also contained statements to the effect that the creditor was entitled to file a proof of claim for any deficiency following the recovery and sale of the collateral.

After the vehicles were repossessed and the creditor began the process of liquidating them, but before the claims bar date, the creditor filed an objection to confirmation of the debtor's plan, which proposed a zero payout to unsecured creditors. The objection to confirmation also gave details of the underlying loans, including the amounts due.

After the collateral was sold, the creditor filed a formal, "amended" proof of claim as an unsecured creditor for the amount of the deficiency. Although the amended claim was filed after the claims bar date, the creditor argued that the amended proof of claim related back to the date of the motions and objection. The debtor responded to the trustee's objection by arguing that the documents previously filed by the creditor did not constitute an informal proof of claim because they failed to state the final amount of the unsecured claim.

However, the exact amount of the claim could not be determined before the deadline for filing proofs of claim because the collateral had not yet been sold. Nonetheless, the bankruptcy court ruled that the documents filed by the creditor prior to the bar date were insufficient to qualify as informal proofs of claim.

Reversing the bankruptcy court's ruling, the Bankruptcy Appellate Panel determined that the written motions filed by the creditor contained the essential elements of an informal proof of claim: they were filed before the claims bar date with explicit demands, showing the nature and amount of the claims against the estate. Further, the creditor's objection to plan confirmation contained a statement that the creditor considered itself to be an unsecured creditor of the estate. The BAP concluded that, as a matter of law, the documents filed with the bankruptcy court were sufficient to put the debtor on notice of the existence of the creditor's claim. Therefore, the formal claim related back to the previously filed motions and objection to plan confirmation.

In re Fish, 2011 Bankr. LEXIS 3512 (B.A.P. 9th Cir. Aug. 3, 2011)

Allocation of Joint Tax Refund Determined by IRS Formula

A Montana bankruptcy court used a formula employed by the IRS when it divides joint tax refunds between spouses to determine the allocation to a Chapter 7 bankruptcy estate of a joint income tax refund received by a debtor and his non-filing spouse.

The trustee filed a motion for turnover of the bankruptcy estate's share of the tax at issue. The trustee and the debtor agreed that the estate was entitled to a share of the refund, but they disagreed on the method to be used to determine the estate's share. The trustee argued that the estate's share should be calculated based on the respective incomes of the debtor and his spouse. On the other hand, the debtor proposed an equal share allocation because the couple held the refund as tenants-in-common and tenants-in-common presumptively own undivided equal interests in their property.

The bankruptcy court rejected both approaches in favor of a blended approach that considers both income and withholding. The court observed that a joint return does not necessarily create equal property interests, and tax refunds should be allocated according to a debtor and non-debtor spouses' contribution to the overpayment. This is because tax refunds do not stem exclusively from income or withholdings. The blended approach used by the court was based on the formula used by the IRS, which calculates each spouse's individual refund by subtracting the spouse's individual liability from the spouse's contribution toward joint liability.

In re Palmer, 2011 Bankr. Lexis 959 (Bankr. D. Mont. Mar 10, 2011)

Statute of Limitation Not a Bar to Collection of Delinquent Taxes

The IRS's collection efforts against a debtor were not barred by the 10-year statute of limitations period under Internal Revenue Code (IRC) Sec. 6502(a)(1) because the limitations period was tolled while the IRS was barred from collecting the tax liability during the debtor's bankruptcy proceedings plus an additional six months, the U.S. Court of Appeals for the Ninth Circuit held.

IRC Sec. 6503(h) suspended the running of the collection period of limitations from the date the couple's bankruptcy petition was filed to a date six months after the bankruptcy court issued its order of discharge. Accordingly, the period of limitations for collecting the couple's outstanding federal income taxes had not expired at the time the couple requested an Appeals Office hearing. The court also determined that the liability itself was not discharged in bankruptcy, even though the debtors' bankruptcy was a "no asset" case. The couple filed their bankruptcy petition less than three years after their taxes were due; therefore, their tax liability was not dischargeable in bankruptcy.

Severo v. Commissioner of Internal Revenue, 2009 U.S. App. LEXIS 25572 (9th Cir. 2009)

Court May Waive Section 521(a)(1) Filing Requirements

In In the Matter of Warren, 2009 U.S. App. LEXIS 13062 (9th Cir. 2009), the Ninth Circuit Court of Appeals ruled recently that a bankruptcy court may waive the filing requirements of Bankruptcy Code Sec. 521(a)(1) thereby avoiding automatic dismissal even if, as in this case, the 45-day filing deadline had elapsed and the case had presumably been dismissed automatically.

According to the appellate court, the deadline set forth in Sec. 521(a)(1) is directed toward debtors, not the bankruptcy courts. Consequently, bankruptcy courts retain discretion to waive the filing requirement of Sec. 521(a)(1), even after the 45-day deadline set forth in Sec. 521(i)(1) has passed.

In Warren, the debtor filed bankruptcy to avoid child support payments. The debtor filed only the emergency forms and not the remainder. The court warned the debtor that his case would be dismissed unless he filed the schedules required to be filed under Sec. 521 and set a hearing to consider dismissal and sanctions. Immediately before the hearing, the trustee advised the court there may be assets to administer and asked the court not to dismiss the case. The court agreed.

Five months later, the debtor filed a motion to dismiss his case, arguing that the 45 days to file the remainder of the schedules under Section 521(i)(1) had run and therefore the court was required to dismiss. The trustee argued that the schedules required to be filed under 521(a)(1) were subject to the proviso "unless otherwise ordered by the court".

But the statutory language in Sec. 521 does not establish a deadline for a court to "order otherwise," and the Ninth Circuit refused to interpret the Sec. 521(i)(1) 45-day filing deadline as a limitation on the court's authority to "order otherwise." To do so would limit a court's powers to prevent abusive bankruptcy filings. A debtor could guarantee that his case would be dismissed simply by declining to comply with the Sec. 521(a)(1) filing requirement.

401(k) Loan Repayment Not A Necessary Expense

In In re Egebjerg, 2009 U.S. App. LEXIS 11651 (9th Cir. 2009), the U.S. Court of Appeals for the Ninth Circuit upheld a bankruptcy court's determination that while the repayment of a 401(k) loan may be a real obligation, it is neither a "secured debt" nor a "necessary expense" for purposes of the means test.

The debtor took a loan from his 401(k) plan two years before he filed for bankruptcy. The retirement plan automatically deducted funds each month from his paychecks to repay the loan. The trustee objected to the debtor's characterization of the monthly payments as a necessary expense. The bankruptcy court rejected the trustee's position and held that the 401(k) loan was a "secured debt" and one that could be deducted from the debtor's monthly income for purposes of the means test. However, the bankruptcy court dismissed the petition because it would be an abuse to permit the case to continue under Chapter 7 given that the loan would be repaid within a year, and the debtor would be left with $525 a month to repay unsecured creditors.

On appeal, the Ninth Circuit overturned the bankruptcy court's ruling and held that the debtor's obligation to repay the 401(k) loan was not a "debt" under the Bankruptcy Code because the debtor had borrowed his own money, and the obligation for repayment was to him. In the event the debtor failed to repay himself, the administrator had no personal recourse against the debtor. Instead, the plan would deem the outstanding loan balance to be a distribution of funds that reduced the amount available to the debtor from his account in the future. Although the deemed distribution would have tax consequences, it did not create a debtor-creditor relationship.

The court also determined that the debtor's 401(k) loan repayments were not "other necessary expenses" for purposes of applying the means test because the initial plan contributions and loan repayments were voluntary and were the functional equivalent of voluntary contributions to a retirement plan under IRS guidelines. Furthermore, the mere obligation to repay a 401(k) loan itself was not a "special circumstance."

Payment to Trustee of Preference Revives Creditor's Non-Dischargeable Claim

A debtor who embezzled money from his employer could not evade repayment of the money taken by making a preferential payment to the employer prior to filing bankruptcy. According to the Ninth Circuit Court of Appeals, if a debtor pays an otherwise non-dischargeable debt to a creditor during the pre-petition preference period and the creditor is forced to return the payment later to the trustee, the debt is resurrected to the extent that the creditor can obtain a non-dischargeable judgment against the debtor.

In In the Matter of Laizure, 2008 U.S. App. LEXIS 23851 (9thCir 2008), the debtor agreed to repay the money he had embezzled from his employer after he was caught. The last payment to the employer was made within the 90-day preference period preceding his bankruptcy filing. Consequently, the creditor returned the third installment payment to the trustee, but it also filed a complaint alleging that the amount recovered by the trustee should be held non-dischargeable.

The bankruptcy court and the Bankruptcy Appeals Panel dismissed the complaint, concluding that there was no debt on the petition date because: (1) the creditor had been fully repaid at that time; (2) no debt existed on the date the complaint was filed because the creditor had not yet returned any money to the estate; and (3) Bankruptcy Code Sec. 502(h) did not revive individual liability that could be imposed on the debtor. Therefore, the employer could not bring the adversary action and the debtor could avoid repaying the money he embezzled.

The Ninth Circuit reversed, holding that by avoiding the debtor's third installment payment to the creditor, the trustee returned the creditor to the same position it was in prior to that repayment. According to Sec. 502(h), if a claim is allowable, its status is that of a claim in existence on the petition date regardless of when, after the petition, the trustee has taken the necessary action and recovered. Moreover, if a claim recovered pursuant to Sec. 550 is determined to be non-dischargeable, Sec. 523 permits that reinstated claim to be brought against the debtor personally.

Retroactive Application of Congressional Amendment Did Not Violate Due Process

In In re Lewis, 2007 U.S. App. LEXIS 25735 (9th Cir. 2007), the Ninth Circuit Court of Appeals has ruled that the retroactive application of a Bankruptcy Code amendment eliminating a provision permitting the discharge of student loans in repayment for seven years was valid, and did not violate the debtor's due process rights, even though the loans would have been dischargeable at the time they were made.

The debtor obtained several student loans and subsequently defaulted on the loans. Later, the debtor filed for bankruptcy and sought a declaration that his obligation to repay his student loans was discharged. The bankruptcy court dismissed the debtor's complaint holding that the version of Bankruptcy Code Sec. 523(a)(8) in effect on the date that the bankruptcy petition was filed, not the version of the statute that was in effect on the date the student loans were made, controlled.

Bankruptcy is a legislatively-created benefit that Congress may alter or withhold at its discretion. Through its power to legislate on bankruptcies, Congress has the power to impair contractual obligations, even retroactively, and the debtor has no superseding right to a discharge in bankruptcy. Congress used this power in 1998, when it amended Sec. 523(a)(8)(A) to repeal the safe harbor and to retroactively eliminate the dischargeability of student loans, such as the debtor's, that had been in repayment for seven years or more. Congress left in place an undue hardship exception to nondischargeability, which was not at issue in the present case. Thus, the debtor's loans were controlled by the 1998 amendments. The court rejected the debtor's contention that he had an absolute right to a discharge in bankruptcy and held that the debtor was not deprived of a property interest.

Correct Identifying Information Critical to Dischargeability of Tax Debt

Due to Chapter 13 debtor's negligence in listing an inaccurate Social Security number (SSN) on his bankruptcy petition and §341(a) notice, proper notice was not given to the state franchise tax board. While the mailing otherwise contained the debtor's correct name and address, the tax board could not be expected to ferret out a debtor's correct information when incorrect identifying information is provided. Consequently, taxes owed by the debtor were not discharged pursuant to 11 U.S.C.S. § 1328.

Ellett v. Stanislaus, 2007 U.S. App. LEXIS 25293 (9th Cir. 2007)

Unborn Child Does Not Affect Household Size for ACP Purposes

For purposes of determining the applicable median family income when calculating the applicable commitment period (ACP), Chapter 13 debtors' unborn child was not a member of their household, the size of which would be determined as of the date of confirmation of a Chapter 13 plan.

There was no intent of Congress reflected either in the language of the Bankruptcy Code as amended by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 or in its legislative history to include unborn children in the terms "household", "person" or "individuals" when used in the definition of "applicable commitment period".

The determination of whether unborn children should be considered as part of the debtors' household was much more relevant to the issue of the debtors' projected disposable income over the life of the plan than to a determination of the appropriate applicable commitment period.

In re Fleishman, 2007 Bankr. LEXIS 2539 (Bankr. D. Or. July 9, 2007)

Substantial Compliance with Credit Counseling Upheld

The District Court for the Eastern District of California recently upheld a bankruptcy court's determination that a Chapter 7 debtor substantially complied with the prepetition credit counseling requirement of Bankruptcy Code Sec. 109(h).

As a preliminary matter, the district court determined that the credit counseling requirements of Sec. 109(h) were non-jurisdictional. Although the debtor received credit counseling from an unapproved service and the counseling was received more than 180 days prior to filing, the court found that the debtor was eligible to file for bankruptcy. The credit counseling was initiated five months prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, when there was no requirement for a bankruptcy petitioner to obtain prepetition credit counseling. In addition, the counseling that the debtor obtained resulted in the type of debt repayment contemplated by Congress in writing Sec. 109(h). The debtor's repayments constituted "briefings" within the meaning of the statute, and the debtor's petition was satisfactory in general.

In re Meza, No. 2:06cv1307-MCE (E.D. Cal., June 22, 2007)

Credit Counseling Not Jurisdictional, Subject to Waiver

A Ninth Circuit Bankruptcy Appellate Panel (BAP) has held that the credit counseling requirement added by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 is not jurisdictional and, therefore, the requirement may be waived by a bankruptcy court.

The debtor filed a Chapter 7 case without first obtaining mandatory credit counseling or complying with the statutory requirements to obtain an extension. The trustee soon discovered significant assets that could be liquidated for the benefit of the debtor's creditors, and the debtor filed a motion to dismiss, relying on a number of cases that have strictly enforced the credit counseling requirement against the debtor.

After reviewing a series of Sec. 109 eligibility issues, the BAP determined that compliance with the credit counseling requirement was a matter of eligibility and, as such, the requirement was subject to waiver. In addition, a bankruptcy court may dismiss a case for cause, but a debtor does not have an absolute right to dismissal. In this case, creditors would have been prejudiced by a dismissal because the debtor's home might have been sold, with creditors potentially being paid in full.

In re Mendez, 2007 Bankr. LEXIS 1252 (Bankr. 9th Cir. 2007)

Oversecured Creditor May Not Recover Attorneys' Fees

An oversecured creditor was not permitted to recover its bankruptcy-related attorneys' fees under Bankruptcy Code Sec. 506(b) because it failed to show that attorneys' fees were authorized under applicable state law.

Chapter 12 debtors were allowed to provide the creditor, a utility company, with adequate assurance of payment under Sec. 366(b). Specifically, the debtors provided the creditor with a first position, postpetition lien in their dairy herd and milk receivables. Subsequently, the debtors sold a large portion of their herd, and disputes arose with the creditor that led to the creditor's request for, among other things, attorneys' fees and costs. The creditor was oversecured, and it conceded that it had no security agreement or any other contract or agreement that provided a right to recover attorneys' fees. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 amended Sec. 506(b) and added "state statute" to the agreement-based fee provision that previously existed.

The bankruptcy court determined that an oversecured creditor relying on a state statute is entitled to Sec. 506(b) fees only if the statute under which the claim itself arose provides for recovery of fees. In this case, the creditor's lien arose under federal law and not any state statute. Although the general fee schedule was a state statute, the creditor's claim did not arise under it.

In re Astle, 2007 Bankr. LEXIS 892 (Bankr. D. Idaho 2007)

Lender Subject to Prohibition against Bifurcating Home Mortgages

A lender's claim for the unsecured portion of its mortgage was disallowed where Section 1322(b)(2) precluded bifurcation of the claim. According to the debtors' Chapter 13 plan, the debtors would surrender their home, which was subject to a mortgage that was worth more than the property. The undersecured lender filed a proof of claim with a secured part up to the market value of the debtors' home and an unsecured part for the remaining balance. The bankruptcy court disallowed the unsecured portion of the lender's claim on the basis that it inappropriately modified the lender's rights. As the holder of the first mortgage on the debtor's home, the lender was entitled to payment of its claim according to the terms of the mortgage, regardless of the value of the property. A plan that would have modified the lender's rights could not have been confirmed; likewise, the lender could not unilaterally modify its rights by filing a proof of claim and then arguing that the debtors' confirmed plan should be interpreted with its proof of claim.

In re Hale, 2007 Bankr. LEXIS 173 (Bankr. E.D.Wash. 2007)

"Same-Day" Credit Counseling Okayed

According to the bankruptcy court in In re Swanson, 2006 Bankr. LEXIS 3639 (Bankr. D. Idaho 2006), debtors may obtain credit counseling on the same day that they file for bankruptcy, provided they complete the counseling before a petition is filed with the court. The debtor in Swanson attended his pre-petition credit counseling session the morning of the day he filed his Chapter 13 petition. While Section 109(h) requires the credit counseling appointment to take place during the 180-day period preceding the filing date, the court found that a same-day briefing satisfied this requirement. The court noted that a narrow reading of Section 109(h) would not serve any stated Congressional intent. Thus, the court concluded that the date of filing used in Section 109(h) refers to the calendar day and time a petition is filed.

10th Circuit

Old Car Deduction Not an Automatic Entitlement

The U.S. Bankruptcy Court for the District of Utah recently ruled that above-median income Chapter 13 debtors were not entitled to an automatic additional operating expense allowance for older vehicles. The Internal Revenue Manual may provide for an additional operating expense of $200 for old or high-mileage cars, but the additional expense is not an expense within the meaning of the "means test."

The Chapter 13 trustee objected to the confirmation of the debtors' plan because their Form 22C took a line-item deduction of $200 for each of their two cars which had over 75,000 miles on them and were more than six years old. The debtors did not claim a commensurate expense on their schedule of expenses, but they argued that the additional operating expense was a standardized allowance that was not subject to review provided the vehicles are old enough or have sufficient mileage to qualify.

The deduction was based on IRS guidelines in connection with offers in compromise that provides an additional monthly operating allowance to taxpayers with a vehicle that is over six years old or has 75,000 reported miles on the odometer. However, the additional allowance is not part of the expense tables incorporated into the Bankruptcy Code's "means test" provisions. An additional expense allowance may be appropriate in bankruptcy, but it is not an automatic entitlement.

In re Hargis, 2011 Bankr. LEXIS 1648 (Bankr. D. Utah May 3, 2011)

Pre-Conversion Misconduct Supports Denial of Discharge

Discharge in a case converted to Chapter 7 from Chapter 13 case was properly denied based on debtors' pre-conversion refusal to comply with provisions of the bankruptcy court's confirmation order, held the U.S. Court of Appeals for the Tenth Circuit. The court's confirmation order was a "lawful order of the court" for purposes of Bankruptcy Code Sec. 727(a)(6)(A), which gives the court the power to deny discharge in a Chapter 7 case if the debtor refuses to obey a lawful order of the court.

The order confirming the debtors' Chapter 13 plan required the debtors to file monthly operating reports with the trustee and provide him with copies of all tax returns due during the life of the plan. The debtors did not file monthly operating returns or send copies of their tax returns to the trustee. Instead, the debtors used extra income received during this period for home improvements; and, when the trustee sought to have the case dismissed, the debtors converted the case to Chapter 7. The bankruptcy then granted the trustee's motion to deny discharge of the debtors' debts based on their misconduct under Chapter 13, and the district court affirmed.

On appeal, the debtors' argued that denial of discharge under Sec. 727(a)(6)(A) was not applicable to their case because (1) a Chapter 13 confirmation order was not a "lawful order of the court" within the meaning of Sec. 727(a)(6)(A); and (2) Sec. 727(a)(6)(A) applied only to a debtor's refusal to obey an order of the court in a Chapter 7.

Because the Code does not define what constitutes a "lawful order of the court," the appeals court turned to the plain meaning of the phrase to conclude that a lawful order of the court is a command that is permitted by law. The provision in the bankruptcy court's confirmation order was a command to the debtor's to provide monthly operating reports and tax returns to the trustee. Further, the Bankruptcy Code permits bankruptcy courts to issue confirmation orders of this type in Chapter 13 cases.

The court of appeals also rejected the debtors' argument that Sec. 727(a)(6)(A) was limited in application to misconduct that occurs in a Chapter 7 case only. As support for their contention that their converted case was separate from their Chapter 13 case, the debtors relied on the fact that a converted Chapter 7 estate and its predecessor Chapter 13 case are comprised of different property. But Sec. 348(a) provides that a converted case is commenced on the date the initial bankruptcy petition was filed, not on the date it was converted. Consequently, a Chapter 13 debtor's post-filing conduct could give rise to an objection to discharge under Sec. 727 following conversion to Chapter 7.

In re Standiferd, 2011 U.S. App. LEXIS 7446 (10th Cir. 2011)

Settlement Rights under Insurance Policy Assignable in Bankruptcy

A bankruptcy trustee has the right to assign a bankrupt doctor's right to consent to settlement under a medical malpractice insurance policy to the medical malpractice plaintiff, according to a recent ruling by the 10th Circuit Court of Appeals in In re Baird, 2009 U.S. App. LEXIS 11930 (10th Cir. 2009).

The debtor doctor filed for bankruptcy two years after a medical malpractice suit was filed against him by a couple alleging injuries to their daughter during her delivery. The couple offered to purchase from the trustee the debtor's right to consent to settlement under the doctor's malpractice insurance. The trustee balked at the couple's offer, maintaining that there was no asset which he could assume and assign to the couple. Indeed, the bankruptcy court ruled that the policy was an executory contract and, because the trustee had not timely assumed the policy, it was not property of the estate.

The Tenth Circuit reversed, holding that the liability policy was property of the debtor doctor's estate. Even though the policy was a continuing one, either party to the contract had the right to discontinue for future periods; therefore, it was unrealistic to regard the contract as one extending indefinitely into the future. Additionally, the debtor's "obligation to provide cooperation in the course of defense to any liability claims" was not significant enough to constitute a continuing material obligation under the contract. Once the debtor paid his premium, there was no way he could underperform in a way that would relieve the insurance company from its obligations.

The court further held that the trustee had the discretion to assign the right to consent to settlement under the policy to the couple. Bankruptcy Code Sec. 541(c)(1) expressly provides that an interest of a debtor in property becomes property of the estate notwithstanding any provision that restricts or conditions transfer of such interest by the debtor. Moreover, under state law, once an event triggering a loss has occurred and the settlement consent right is assigned in bankruptcy to a trustee, there is no limitation on the trustee's further assignment of the right to another party. Even if the right was personal and non-transferrable in the first place, once it has been transferred to the trustee, it ceases to be personal, and there is no reason to forbid a further transfer.

Bail Bond Guarantees Dischargeable

A judgment obtained before the filing of a case for the guarantee of payment to a bail bond company on an appearance bond was dischargeable because Sec. 523(a)(7) did not apply because the bondsman was not a governmental unit.

A professional bail bondsman posted two bonds as surety for the promise of a criminal defendant to appear in court as ordered or forfeit the bonds, totaling $16,000. The day before the bonds were posted, the debtor signed a "plain-talk" contract and a bond agreement agreeing to indemnify the bondsman for the full amount of the bond posted in the event the defendant failed to appear. After the defendant failed to appear for trial, the bail bondsman obtained a default judgment against the debtor. After the debtor filed for bankruptcy, the bondsman brought an adversary proceeding and sought a determination that the judgment was non-dischargeable under Sec. 523(a)(7).

The debt was not payable to, and for the benefit of, a governmental unit. The bondsman was not a governmental unit, and the fact that she ultimately paid money to the state after the defendant failed to appear for trial did not change her status from that of a private corporate entity.

In re Sandoval, 2008 U.S. App. LEXIS 19293 (10th Cir. 2008)

Lender Entitled to Interest on 910 Car Loans

In In re Jones, 2008 U.S. App. LEXIS 17423 (10th Cir. 2008), the Ten Circuit Court of Appeals held that creditors who finance a debtor's purchase of a 910 car are entitled to post-petition interest on plan payments. When a debtor chooses to make periodic payments on a claim, the amount of each installment must be calibrated to ensure that, over time, the creditor receives disbursements whose total present value equals or exceeds that of the allowed claim. In the absence of express language linking the meaning of "allowed secured claim" in Sec. 1325(a)(5) to Sec. 506, a claim that is allowed under Sec. 502 and secured by a lien on a 910 vehicle is an allowed secured claim under Sec. 1325(a)(5).

Abuse Presumed, Dismissal Not Mandatory

In In re Skvorecz, 2007 Bankr. LEXIS 1572 (Bankr. D. Colo. May 8, 2007), the debtor's case was not dismissed even though the absence of a deduction or other adjustment to current monthly income for 401(k) contributions or 401(k) loan repayments led to a presumption of abuse. Under the circumstances of the case, dismissal would have led to an absurd result.

The debtor scheduled a monthly contribution to his 401(k) plan and a 401(k) loan repayment. In a Chapter 13 bankruptcy, the debtor would be allowed to deduct the loan payments and contributions from the calculation of his current monthly income, and he would have no disposable income, which would result in a zero dollar distribution to unsecured creditors. Nonetheless, the trustee assigned to the case argued that, once the presumption of abuse arises and no purpose is served by the debtor converting to another Chapter of the Code, the intent of Congress was to deny bankruptcy relief altogether.

The bankruptcy court concluded that dismissal was not a necessary conclusion even though the presumption of abuse applied. The language of Sec. 707(b)(1) is permissive, providing that a court may dismiss or convert a case. If the court dismissed the debtor's case or he filed under Chapter 13, unsecured creditors would be paid nothing. The intent of Congress in tying Chapter 7 relief to a means test was to require a debtor to repay his creditors if he was able to. According to the court, "it would be nonsensical that the very payments or expenses which tip the calculation so as to create the presumption of abuse, an indication of an ability to repay, are the same payments or expenses that are excepted from disposable income in a Chapter 13".

Trustee May Avoid Unperfected Lien at Time of Bankruptcy

A bankruptcy trustee was permitted to avoid a credit union's lien that was not perfected as of the date Chapter 7 debtors filed for bankruptcy even though a state department of revenue had issued an inappropriate title certificate to the debtors.

Married debtors purchased a vehicle and granted a purchase money security interest in the vehicle to the credit union. The wife signed a notice of security interest (NOSI) in favor of the credit union. The credit union mailed a check to the state department of revenue with the NOSI form to perfect its security interest. The department of revenue (DOR) acknowledged receiving the NOSI, but the transaction was not entered into the agency's computer as it should have been. Due to the DOR's error, nearly five months elapsed subsequent to the debtors' bankruptcy filing in which the agency's digital records showed the debtors to be the owners of the vehicle with no lien. At issue was whether the NOSI outlasted the subsequent issuance of a title certificate that failed to reflect the credit union's lien.

The Tenth Circuit found it compelling that the state statute only required the DOR to keep the NOSI on file until it had received an application for a certificate of title to the vehicle and the certificate of title had been issued. Once a lien holder availed itself of the permanent method of perfection by notation on the certificate of title, the temporary perfection created by the NOSI disappeared. In this case, the trustee had no official notice of the lien and was entitled to exercise the strong-arm powers of the Bankruptcy Code to avoid it.

In re Hicks, 2007 U.S. App. LEXIS 15114 (10th Cir. 2007)

Creditor's Substantive Rights Unaffected by Bankruptcy Rule

According to a recent decision by the United States Court of Appeals for the Tenth Circuit, Bankruptcy Rule 4001(a)(3) does not stay the termination of the automatic stay beyond the 30-day stay duration provided by Code Sec. 362(e).

The debtor, who had defaulted on a loan owed on her truck, filed a bankruptcy petition one day before the secured creditor's hearing on a replevin action in state court. The creditor sought relief from the stay under Sec. 362(d), arguing that its claim was not adequately protected. The bankruptcy court lifted the stay, and the creditor repossessed the truck nine days later. The debtor then sought an order of contempt against the creditor because the repossession violated the 10-day stay of such orders created by Bankruptcy Rule 4001(a)(3). However, the termination of the automatic stay under Sec. 362(e) provides a substantive right to creditors to recover their collateral, when the property is security for a debt. To the extent that Rule 4001(a)(3) modified such a right, the rule was ineffective.

In re Duran, 2007 U.S. App. LEXIS 7689 (10th Cir. 2007)

Student Loan Payments Special Circumstance Under "Means Test"

Where the application of the means test resulted in the statutory presumption of abuse arising, debtors were able to rebut the presumption by demonstrating that student loan payments presented "special circumstances." It was undisputed that the debtors' student loans were not dischargeable or eligible for deferment or consolidation. Thus, there was nothing the debtors could do to reduce or otherwise avoid the additional expense of the student loans. The court rejected the U.S. Trustee's position that special circumstances must be of an entirely involuntary nature, noting that neither example used in the Code-medical condition or military service-were of a entirely involuntary nature.

In re Templeton and Williams, 06-11567-BH (Bankr. W.D. Okla. 2007)

Applicable Commitment Period Irrelevant if DMI is Negative

A Utah bankruptcy court directed a trustee in two Chapter 13 cases to submit modified confirmation orders, finding that the "applicable commitment period" of Section 1325(b)(4) is "fundamentally irrelevant" for above-median debtors with negative monthly disposable income. The debtors were not required to make any payments to unsecured creditors, thus the court reasoned that requiring the debtors to pay nothing for 60 months, or any length of time for that matter, would serve no purpose. Rather, the duration of a Chapter 13 plan for an above-median income debtor who has negative disposable monthly income should be determined by the length of time needed to make mandatory payments, such as those to secured, priority or administrative creditors.

In re Lawson, 2007 Bankr. LEXIS 174 (Bankr. D. Utah 2007)

Below-Median Debtor Must Propose 36-Month Plan

A below median income debtor who had disposable income available was required to commit her projected disposable income to the payment of unsecured creditors for a three-year period instead of the proposed 18 month period. Because the debtor had below-median income, the space for disposable income on the means test was blank. The debtor argued that blank was equal to zero and, therefore, the amount required to be paid to her unsecured creditors based on her disposable monthly income was zero. However, the debtor was not entitled to calculate disposable income using the means test so her monthly disposable income was not zero. Without endorsing a specific approach for determining the amount of a below-median debtor's disposable income, the debtor's disposable income was either $305 per month based on Schedule I minus Schedule J or $600 per month based on the debtor's current monthly income minus Schedule J.

In re Daniel, 2006 Bankr. LEXIS 3456 (Bankr. D. Kan. 2006)

Engagement Ring Not Estate Property

An engagement ring did not become property of a Chapter 7 debtor's bankruptcy estate because the debtor ended the engagement and returned the ring to her fiancé. While the ring was a conditional gift under state law, the creditor argued that the right to accept or reject the gift passed to the debtor's bankruptcy estate. But this was not the typical case where the debtor has to do nothing but passively accept the gift. The debtor had to do something much more significant: she had to marry her fiancé. The general bankruptcy policy of distributing property for the benefit of a debtor's creditors does not in this case oblige the debtor to fulfill the condition on the gift of the ring by marrying the fiancé. Consequently, breaking off the engagement had the effect of reverting ownership of the ring to her fiancé when the debtor ended the engagement.

In re Heck, 2006 Bankr. LEXIS 3316 (Bankr. D.Kan. 2006)

11th Circuit

Creditor Not Entitled to Contract Interest Rate Post-Confirmation

The U.S. Court of Appeals for the Eleventh Circuit affirmed bankruptcy and district court rulings in a Chapter 13 case that an oversecured creditor was entitled to interest at the contract rate only until confirmation of the debtor's plan. After confirmation, the creditor would be paid interest at a lower "prime-plus" rate determined under the standard in Till v. SCS Credit Corp., 541 U.S. 465 (2004).

The creditor's claim was fully secured by personal property worth more than the amount of the claim. The contract rate of interest was 10.5 percent; however, the debtor's plan invoked the cram down provision of Bankruptcy Code Sec. 1325(a)(5)(B) and provided for payment of interest at the reduced rate of 4.25 percent, which was calculated using the prime-plus approach adopted by a plurality in Till. The creditor objected to confirmation of the debtor's plan, arguing that, as an oversecured creditor, its claim would have to be paid interest at the contract rate according to Sec. 506(b). The bankruptcy court sustained the creditor's objection in part, and overruled in part, holding that the amount of the creditor's allowed claim included interest accrued through plan confirmation at the contract rate. Although Sec. 506(b) required the payment of accrued interest at the contract rate from the date of filing until the date of plan confirmation, post-confirmation, the lower Till rate would apply. The district court affirmed the bankruptcy court's holding.

The court of appeals affirmed the lower courts' holdings that interest accrues under §506(b) only from the date of filing through confirmation if the debtor invokes the cram down provision of Sec. 1325(a)(5)(B). The court observed that if Sections 506(b) and 1325(a)(5)(B) both applied post-confirmation, the creditor would receive a windfall. The amount of the secured creditor's claim is set at confirmation and includes postpetition contract interest. Therefore, if a secured claim accrues interest at the contract rate post-confirmation, the creditor would collect "interest upon interest" that would exceed the present value of the claim under Sec. 1325(a)(5)(B).

First United Security Bank v. Garner (In re Garner), 2011 U.S. App. LEXIS 23811 (11th Cir. Nov. 30, 2011)

Debtors Get Bankruptcy Exemption for Inherited IRA

Chapter 7 debtors' inherited IRA was exempt under federal law even though the debtors' state had opted out of the federal property exemptions and the IRA would probably not have been exempt under state law, ruled the U.S. Bankruptcy Court of the Middle District of Florida. An exemption may be taken under Bankruptcy Code Sec. 522(b)(3)(C) for an inherited IRA to the extent that the retirement funds are exempt from taxation under the Internal Revenue Code.

In In re Nessa, 426 B.R. 312 (Bankr8thCir 2010) the Bankruptcy Appellate Panel for the Eight Circuit considered the application of the federal exemption scheme to inherited IRAs. The BAP found that for an inherited IRA to be exempt under the federal property exemptions, the IRA funds must be "retirement funds" and held in an account that is exempt from taxation under the Internal Revenue Code. While the IRA was inherited, the court determined that the funds in it were nonetheless "retirement funds." Additionally, IRAs are tax exempt under Internal Revenue Code Sec. 408 and they do not lose their tax exempt status upon the death of the account holder provided the funds are properly transferred to the beneficiary. Finding that the debtor's inherited IRA qualified as tax exempt under the Internal Revenue Code, the BAP concluded that the debtor's inherited IRA was exempt under Sec. 522(d)(12).

However, the debtor in Nessa relied on the federal property exemptions of Sec. 522(d) rather than her state's exemptions to protect her inherited IRA from creditors. The debtors in this case, while they followed the required formalities for an "inherited" IRA under the Internal Revenue Code, were not allowed to use federal property exemptions and, therefore, Sec. 522(d) was not available to them as it was to the debtor in Nessa.

Prior to BAPCPA, debtors in states that had opted out of the federal exemptions had to look solely to state law for retirement fund exemptions. However, post-BAPCPA, Bankruptcy Code Sections 522(b)(3)(C) and 522(d)(12) afford equal treatment to exemption claims of retirement funds whether a state opts in or opts out of the federal exemptions. Given the identity of Sec. 522(b)(3)(C) to Sec. 522(d)(12), the court adopted and extended Nessa to inherited IRAs claimed as exempt under Sec. 522(b)(3)(C).

In re Mathusa, 2011 Bankr. LEXIS 965 (Bankr. M.D. FLa. 2011)

Claim Modification and Maintenance of Payments Not Mutually Exclusive

A debtor could modify a non-residential real property loan under Bankruptcy Code Sec. 506(a) and maintain payments beyond the life of his Chapter 13 plan as long as the monthly payments and interest rate were the same as those provided in the original note, ruled the U.S. Bankruptcy Court for the Southern District of Florida. The debtor originally proposed a plan that would re-amortize the secured portion of the creditor's claim over a period of time that extended beyond the term of the plan, at a reduced interest rate, resulting in significantly lower monthly payments.

The creditor objected to confirmation of the debtor's plan, arguing that the debtor could not reduce or otherwise modify the creditor's secured claim and then propose to repay the loan over a period longer than the plan term. According to the creditor, Sec. 1322(b)(2), which allows modification of secured claims, and Sec. 1322(b)(5), which authorizes a debtor to cure prepetition arrearages and maintain long term payments, are mutually exclusive.

The bankruptcy court ruled that the two sections are not mutually exclusive. However, a debtor may both modify the rights of a creditor and cure and maintain payments only if the modification will not alter the original repayment terms of the loan. The debtor in this case proposed a plan that would repay the mortgage over the long term at an interest rate and monthly payments much lower than those in the original loan agreement; therefore, the debtor's plan could not be confirmed.

In re Elibo, 2011 Bankr. LEXIS 906 (Bankr. S.D. Fla. 2011)

Duration of Chapter 13 Plan Fixed by Bankruptcy Code

In Whaley v. Tennyson (In re Tennyson), 2010 U.S. App. LEXIS 14638, the 11th Circuit Court of Appeals ruled that an above median income debtor must propose a five-year plan even if the debtor's disposable income is negative. Aligning itself with the majority of courts that have ruled on the issue, the appeals court concluded that the "applicable commitment period" is a temporal requirement, thus rejecting the competing view that the "applicable commitment period" is a mere multiplier, or monetary concept.

The 11th Circuit determined that Sec. 1325(b)(4), which establishes the duration of a Chapter 13 repayment plan, sets the absolute maximum time period of a Chapter 13 plan for an above-median income debtor at five years, with no exceptions. The competing view is that the "applicable commitment period" imposes a monetary requirement. Once the debtor pays whatever amount is determined at confirmation to be due to unsecured creditors, the plan can end. However, the appeals court reasoned that its interpretation was supported not only by a plain reading of the statute, but also by the purpose of the BAPCPA amendments-to require that above-median income debtors pay more to creditors by remaining in bankruptcy for a fixed period of time, unless all unsecured claims are paid in full.

Bank to Bank Transfers Avoidable

A Chapter 7 debtor's payment of a credit card debt using balance transfers and credit card advances drawn on other credit cards constituted avoidable preferential transfers. Within 90 days of filing her bankruptcy petition, the debtor decided to consolidate her debt into one credit card. To accomplish this, the debtor used cash advances from one credit card account and a convenience check from another to make three payments to a third creditor.

Having established the five elements required by Bankruptcy Code Sec. 547(b), the trustee's motion to avoid the transfers as preferential was granted by the bankruptcy court. The district court affirmed.

The transfers could only be avoided if the funds used were property that would have been part of the debtor's estate had it not been transferred before the commencement of the bankruptcy proceedings. Here, the debtor caused one credit card company to directly transfer funds to another. Nonetheless, the debtor had sufficient control over the funds used to pay the credit card debt, even if her interest in the money was fleeting, and she herself directed the other credit card companies to make the payments at issue. Once the lines of credit had been extended to the debtor, she could have used them to pay other creditors or purchase other assets, but because she chose to pay off her credit card debt, those other creditors were denied payment or an opportunity for payment. Therefore, the transfers at issue diminished the available assets in the estate.

In re Egidi, 2009 U.S. App. LEXIS 13198 (11th Cir. 2009)

Deficiency Claim Following Surrender of 910 Vehicle Governed by Contract

Joining the Seventh, Eighth, Tenth, and Fourth Circuits, the Eleventh Circuit recently held that a creditor may pursue an unsecured deficiency claim when a debtor surrenders a so-called 910 vehicle.

The debtors filed a Chapter 13 bankruptcy plan, proposing to surrender the vehicle in full satisfaction of the debt owed to their secured creditor. The creditor objected because the plan did not provide for the payment of any deficiency claim after disposition of the vehicle.

In a consolidated appeal, the court agreed with its five sister circuits that a plain reading of the hanging paragraph in Bankruptcy Code Sec. 1325(a) made clear that Congress intended to (and did) make Sec. 506(a) inapplicable to 910 vehicles. Thus, "by knocking out [Sec.] 506", the parties are left to their contractual entitlements and applicable state law.

In re Barrett, 2008 U.S. App. LEXIS 20466 (11th Cir. 2008)

Plan Must Provide For Payment of Post-Petition Interest on 910 Car Claim

A claim that falls within the "hanging paragraph" at the end of Bankruptcy Code Sec. 1325(a)(9) is an allowed secured claim entitling the creditor to payment in full, plus post-petition interest, according to the Eleventh Circuit Court of Appeals in In re Dean, 2008 U.S. App. LEXIS 16625 (11th Cir.).

The debtors purchased a vehicle for their personal use within 910 days prior to filing for bankruptcy. The sales contract provided for a finance charge of 16.95 percent. When the debtors later filed for bankruptcy, the unpaid balance on the car loan was $14,571.52; nonetheless, the debtors proposed a repayment plan in which they would pay $8,475 (the then current market value of the car), plus interest at a rate of 7.5 percent.

Prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), a Chapter 13 debtor could use Sec. 506(a)(1) to cram down or bifurcate their claims by treating the present value of the collateral as a secured claim, while leaving the remaining portion as an unsecured claim and shared, pro rata, with other unsecured creditors. Under BAPCPA, Congress amended Sec. 1325(a) so that Sec. 506 no longer applied to the holder of a 910 claim. The appellate court sided with the majority of courts that have determined that the hanging paragraph meant only that 910 claims could not be bifurcated into secured and unsecured portions and that such claims had to be treated as fully secured. Moreover, the appellate court agreed with the analysis of the Tenth Circuit's decision in In re Jones, 2008 U.S. App. LEXIS 17423 (10th Cir. 2008), and fully adopted it as its own.

Negative Equity Constitutes PMSI, Bifurcation of Claim Prohibited

In a case of first impression at the circuit level, the U.S. Court of Appeals for the Eleventh Circuit recently ruled that a debtor's negative equity in his trade-in vehicle constituted a purchase money security interest that was entitled to the anti-bifurcation protection of the so-called "hanging paragraph".

The debtor purchased a pick-up truck for his personal use. As part of the transaction, the debtor traded in another truck with a market value less than what was owed on it. The negative equity was rolled into the purchase price of the new vehicle, and the entire amount was financed. The end result was that his new loan was in the amount of $36,384, for a new vehicle with a sale price of $32,929.

Less than a year later, the debtor filed for Chapter 13 bankruptcy. The debtor proposed a Chapter 13 plan that sought to modify the creditor's secured claim by bifurcating it into secured and unsecured portions based on the retail value of the vehicle. The creditor objected to confirmation of the proposed plan, arguing that its secured claim could not be modified through cram down because it fell within the hanging paragraph, which bars cram down of 910 vehicles.

On appeal, an Eleventh Circuit panel determined that rolling negative equity into the financing of a new vehicle does not change the purchase money character of the loan. State law (Georgia) permitted negative equity in a trade-in vehicle to be added to the cash sales price of a new vehicle without precluding the financing creditor or its assignee from taking a purchase money security interest in the new vehicle. Moreover, negative equity is more properly regarded as a debt, rather than antecedent debt, for the money required to make the purchase the new vehicle. Based on the UCC's Official Comments, there is a close nexus between the negative equity in the debtor's trade-in vehicle and the purchase of his new vehicle. The negative equity is an integral part of, and inextricably intertwined with, the sales transaction. The court also noted that its interpretation of the hanging paragraph is consistent with its purpose, which is to require a debtor electing to retain a 910 vehicle to pay the creditor the full amount of the claim and not an amount equal to the present value of the vehicle.

In re Graupner, 2008 U.S. App. LEXIS 16582 (11th Cir.)

Post-Confirmation Assets Are Property of the Estate

Causes of action arising after the confirmation of a Chapter 13 debtors' plan but before the completion of their plan payments became property of the bankruptcy estate, according to the Eleventh Circuit Court of Appeals in In re Waldron, 2008 U.S. App. LEXIS 16457 (11th Cir.).

The debtors were involved in a car accident after the confirmation of their plan but before they completed their payments under the plan. The bankruptcy court approved the settlement of the debtor-husband's claim against the other driver for $25,000 and the disbursement of that amount to the debtors as exempt property. However, with respect to the debtor-husband's claims for underinsured motorist benefits against the insurance company, the remaining claims were determined to be property of the estate.

At issue was whether the debtor-husband's claims for underinsured motorist benefits, which arose after confirmation of the debtors' plan to pay their creditors, were property of the estate under Sec. 1306(a) or whether those claims were vested in the debtor-husband under Sec. 1327(b).

The Eleventh Circuit reasoned that any claims acquired by the debtors after the commencement of their bankruptcy case but before the case was dismissed, closed or converted were property of the estate under the plain language of Sec. 1306(a). New assets that the debtors acquired unexpectedly after confirmation, by definition, did not exist at confirmation and could not be returned to him under Sec. 1327(b). In addition, the bankruptcy court did not abuse its discretion when it required the debtors to amend their schedules to disclose any settlement the debtor-husband acquired after confirmation. Although the debtors did not have a "free-standing duty to disclose the acquisition of a property interest after plan confirmation," the bankruptcy court had the discretion, under Rule 1009, to require the debtor to amend his schedule of assets to disclose a new property interest acquired after the confirmation of the debtor's plan.

Trustee May Not Administer Exempt Assets for DSO Creditors

Funds held in a Chapter 7 debtor's exempt individual retirement account (IRA) were not subject to domestic support obligation (DSO) claims. The bankruptcy court rejected the trustee's contention that Sec. 522(c)(1) made the debtor's IRA subject to administration by the trustee for distribution to holders of DSO claims. Bankruptcy Code Sec. 522(c) provides that property, which is exempt from the estate, is not liable to the claims of creditors even after the bankruptcy case is closed. Those creditors whose debts survive the debtor's discharge may not pursue exempt property, even after the bankruptcy case has played itself out. However, the bankruptcy court concluded that Sec. 522(c)(1) removed that bar for two narrowly defined classes of claims -- taxes and DSO claims. Congress has given those creditors a green light to pursue exempt property after the debtor obtains a discharge.

In re Waters, 2007 Bankr. LEXIS 2184 (Bankr. M.D. Ala. 2007)

Debtor Rejects Executory Contract for Sale of Exempt Property

A trustee's authority to assume or reject executory contracts is not limited to contracts involving non-exempt property. In In re Rabin, 2007 Bankr. LEXIS 243; 20 Fla. L. Weekly Fed. B 234 (Bankr. S.D. Fla. 2007), the Chapter 13 debtor entered into a pre-petition contract to sell his condominium. The debtor proposed to reject the contract so the buyer objected to confirmation of the debtor's plan. The bankruptcy court sustained the buyer's objection and the debtor converted his case to Chapter 7.

The trustee did not assume the contract for sale within 60 days following conversion of the case to Chapter 7, and the buyer filed a complaint seeking specific performance of the contract. Ordinarily, when the trustee fails to act on an executory contract, the contract is deemed rejected. But the buyer argued that the trustee could not assume nor reject the contract and, therefore, the contract for the sale of the condominium was unaffected by the trustee's failure to act. Vacating an earlier ruling, the bankruptcy court found that the pre-petition contract to sell the debtor's home could be rejected in bankruptcy. The court also ruled that the buyer's right to seek specific performance was a claim discharged in the bankruptcy case.

Court Denies Motion to Incur New Debt

In In re Hammett, 2007 Bankr. LEXIS 73 (Bankr. M.D. Ala), the bankruptcy court refused a Chapter 13 debtor's request to finance the purchase of a new car. While the debtor had a very long distance commute to work and his current automobile may have been unreliable and expensive to operate, a request that will diminish a debtor's disposable income may not be approved unless the new debt is essential to a plan's completion. The debtor failed to demonstrate that he needed a new car in order to complete his plan payments or that the new obligation would not affect his disposable income.

"Hanging Paragraph" Not Applicable to Car Used by Spouse

The hanging paragraph provision of Section 1325(a) is not invoked by a vehicle that is acquired for the use of a non-debtor spouse. In In re Davis, 2006 Bankr. LEXIS 3465 (Bankr. M.D.Ala. 2006), the debtor and her husband purchased a car for the husband's use within 910 days pre-petition. Both spouses' names were on the note and certificate of title; however, the husband was the only one who used the car. Applying a literal interpretation, the hanging paragraph applies only to vehicles that are purchased for the "personal use of the debtor."

DC Circuit

Attorney-Client Privilege Does Not Attach to Draft Bankruptcy Forms

The attorney-client privilege did not protect information contained in draft bankruptcy forms from disclosure in a debtor's prosecution for bankruptcy fraud because the debtor intended his attorney to reveal the information contained in the drafts in his bankruptcy filings. Draft bankruptcy filings are no more entitled to protection on the basis of privilege than are the filing actually made. Neither were the draft versions of the debtor's bankruptcy forms protected attorney work product. The work product doctrine protects materials prepared "in anticipation of litigation." The bankruptcy filing was not itself "litigation" in anticipation which the draft forms were created.

U.S. v. Naegele, Criminal No. 05-0151, (D.D.C. 2007)